TABLE OF CONTENTS - The Wall Street...
Transcript of TABLE OF CONTENTS - The Wall Street...
TABLE OF CONTENTS
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SUMMARY.....................................................................................................................................1
INTRODUCTION AND OVERVIEW ...........................................................................................5
Direct Business Model.........................................................................................................9
Superior Quality Products..................................................................................................10
Customer Service and Satisfaction ....................................................................................11
Successful Cost-Cutting Efforts.........................................................................................13
Intel Relationship ...............................................................................................................15
Record Financial Results ...................................................................................................15
High Quality of Financial Results......................................................................................17
Forecasts of Future Growth ...............................................................................................18
PARTIES .......................................................................................................................................32
JURISDICTION AND VENUE ....................................................................................................52
BACKGROUND TO THE CLASS PERIOD ...............................................................................52
CLASS PERIOD FALSE STATEMENTS AND DECEPTIVE CONDUCT...............................53
INTEL’S LIABILITY..................................................................................................................187
DELL’S MISLEADING FINANCIAL STATEMENTS AND DISCLOSURES.......................192
Dell’s Failure to Properly Account for Warranty Liabilities ...........................................195
OptiPlex™ Products ........................................................................................................196
Dell Failed to Make Required Disclosures About the Existence, Impact and Uncertainty of Intel Rebates ................................................................................200
The SEC and DOJ Investigations into Dell’s Accounting May Lead to a Restatement of Dell’s Past Financial Statements – an Admission that Those Financial Statements Were False ..............................................................205
DELL’S FALSE SARBANES-OXLEY CERTIFICATIONS IN ITS SEC FILINGS ...............208
PRICEWATERHOUSECOOPERS’ LIABILITY.......................................................................214
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PWC’s False Statements as to Dell’s Financial Statements ............................................215
PWC Ignored the Audit Evidence It Gathered ................................................................219
PWC Failed to Design Its Audit to Identify the Alleged Improprieties ..........................220
PWC’s Audit Procedures Violated Fundamental Concepts of GAAS ............................223
SCIENTER AND SCHEME ALLEGATIONS...........................................................................224
THE DELL DEFENDANTS’ ILLEGAL INSIDER TRADING ................................................237
NO SAFE HARBOR ...................................................................................................................241
DURA LOSS CAUSATION........................................................................................................242
CLASS ACTION ALLEGATIONS ............................................................................................245
FIRST CLAIM FOR RELIEF .....................................................................................................246
Violation of §10(b) of the 1934 Act and Rule 10b-5 Against All Defendants ................246
SECOND CLAIM FOR RELIEF ................................................................................................248
Violation of §20(a) of the 1934 Act Against Dell and the Dell Defendants....................248
THIRD CLAIM FOR RELIEF ....................................................................................................249
Violation of §20A of the 1934 Act Against the Insider Selling Defendants ...................249
PRAYER......................................................................................................................................250
JURY TRIAL DEMANDED.......................................................................................................251
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SUMMARY
1. This is a securities class action brought on behalf of persons who purchased the
publicly traded securities of Dell, Inc. (“Dell” or the “Company”) between 2/13/03 and 9/8/06.
This Complaint is brought by institutional investors who suffered millions of dollars of losses
due to the wrongdoing alleged herein. The defendants named herein are Dell, several of Dell’s
top officers and directors (collectively the “Dell Defendants”), Intel Corporation (“Intel”), Dell’s
sole supplier during the Class Period of microprocessors/chips for the computer products Dell
manufactured, and PricewaterhouseCoopers LLP (“PWC”), which served as Dell’s outside
accounting firm and audited and certified Dell’s financial statements for fiscal years 2003, 2004
and 2005. This suit alleges violations of the Securities Exchange Act of 1934 (the “1934 Act”)
based on false statements and a scheme and wrongful course of business that operated as a fraud
or deceit on purchasers of Dell’s publicly traded securities, which misconduct involves one of
the largest insider trading “pump-and-dumps” in history.
2. The Dell Defendants made a series of false and misleading statements
representing that Dell’s unique business model, i.e., “Dell Direct,” whereby Dell manufactured
computer products (using Intel microprocessor/chips exclusively) and sold them directly to
individuals, small businesses and corporations, gave Dell a structural competitive advantage and
was succeeding – producing exceptional financial results due to high-quality products (resulting
from stringent quality control and component part testing procedures) and superior customer
support and service and Dell’s unique ability to take advantage of falling component part prices.
They also told investors Dell was successfully cutting billions of dollars of operating expenses,
yielding record low operating expenses as a percentage of revenue, leading to record high
operating profits and margins, net income and earnings per share (“EPS”). The Dell Defendants
stressed that these massive operating expense cuts, including large manufacturing and product
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warranty cost reductions, were being achieved without reducing Dell’s stringent quality control
and component part testing procedures or impairing Dell’s traditional high product quality and
outstanding customer service and support, leaving Dell’s high customer satisfaction ratings –
which had driven Dell’s past success and were indispensable to Dell’s continued sales, i.e.,
revenue growth – intact. They also assured investors that Dell’s “high quality” record financial
results were being achieved with “integrity” and without any undisclosed fraud – material or not
– and that Dell’s reported financial results and disclosures contained in its SEC filings were
supported by an adequate system of internal financial, accounting and disclosure controls as
required by the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”). Based on the foregoing, they
repeatedly forecast 15+% annual revenue – and strong operating income and profit margin
growth going forward for Dell – stressing that the Dell Direct model enabled Dell to achieve
strong profitable growth in all environments – including in times of slowing PC demand when,
they assured investors, the Dell Direct model “thrived.”
3. Prior to the start of the Class Period, in late 2002, Dell’s stock fell sharply as
Dell’s principal competitor, Hewlett-Packard, reportedly surpassed Dell in global PC sales,
raising questions with some analysts as to Dell’s ability to compete effectively. In just a few
weeks, by mid-2/03, this sharp drop had wiped out over $20 billion in Dell’s stock market
capitalization and over $1 billion in the value of Dell’s top insiders’ vested stock options.
However, during the Class Period, the Dell Defendants’ positive statements, Dell’s falsified
financial reports and the scheme to defraud artificially inflated Dell’s stock from a low of $22.59
per share in mid-2/03 to a Class Period high of $42.57 per share in 12/04, a 90% price increase
that substantially outstripped the performance of the stocks of other publicly traded computer
equipment sellers. As Dell’s stock moved higher during the Class Period, the Dell insiders’
stock options went back “in the money” and became worth billions of dollars. Dell’s insiders
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took advantage of this artificial inflation in Dell’s stock price, selling off an enormous amount of
their Dell stock – nearly 99 million shares – for illegal insider trading proceeds of $3.3 billion!
Many insiders sold off over 90% of their Dell shares. Dell’s CEO sold off 98.6% of his shares.
Dell’s CFO sold off 99% of his shares. Dell’s CAO sold off 96% of his shares. The two
executives in charge of Dell’s U.S. consumer business sold off 97% and 100% of their shares.
The Dell Defendants furthered the fraudulent scheme by causing Dell to spend over $12 billion
in corporate funds to repurchase over 350 million shares of Dell common stock on the open
market – manipulating that stock price higher, while, at the very same time, they were selling off
huge amounts of the Dell shares that they owned.
4. In 3/05, Japanese antitrust authorities charged that Intel had been illegally paying
hundreds of millions of dollars of secret rebates to computer manufacturers like Dell to get them
to purchase microprocessor/chips exclusively or virtually exclusively from Intel – charges Intel
did not contest. Then, in mid-2005, negative information surfaced concerning (i) the seriously
flawed state of Dell’s “Dell Direct” business model; (ii) Dell’s widespread product quality
problems and its terribly troubled customer sales, support and service operations; and (iii) a huge
(over $400 million) write-off by Dell for defective capacitors/motherboards, followed by Dell
revealing the largest product recall (over four million PC/notebook lithium batteries) in history,
with resulting widespread customer dissatisfaction and adverse publicity. Also disclosed was (i)
Dell’s dependence on, and the apparent loss of, multi-hundred million dollar end-of-quarter
secret (and possibly illegal) rebates/kickbacks from Intel, called e-CAP payments (which had
secretly been used to boost Dell’s operating profits and margins); and (ii) prior financial
irregularities, plus Securities and Exchange Commission (“SEC”) civil, and U.S. Department of
Justice (“DOJ”) criminal, investigations into Dell’s past financial practices. As Dell reported
very poor operating results, including sharply declining operating profits, margins and net
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income, Dell also revealed it was being forced to make major changes to its “Dell Direct” model,
requiring a massive – and very expensive – rebuilding of its customer support and service
operations, including opening at least 10 additional customer service and support centers, the
hiring of some 10,000 additional employees and the restoration of the product warranty
coverages it had earlier eliminated. Dell also admitted that it was not able to file current period
financial statements as required by the SEC and the Nasdaq and has not done so now for
many months. Due to these negative factors, Dell’s F07 income declined by close to a billion
dollars from F06 and Dell’s future revenue and profit growth prospects are now much worse
than represented during the Class Period. Ultimately, Dell’s CFO, James M. Schneider, resigned
and it has been publicly reported that European Union investigators have recommended that the
European Antitrust Commission formally charge Intel with illegally thwarting any competition
in the computer chip market due to the “exclusivity” discounts provided PC manufacturers,
including Dell.
5. As this negative information entered the market, Dell’s stock plunged from its
Class Period high to as low as $18.95 per share, wiping out almost $60 billion in market
capitalization, falling much further and faster than stocks of other computer equipment
manufacturers. The decline in the prices of Dell’s publicly traded securities, i.e., stock and
options, was caused by a series of company-specific revelations of adverse information that had
previously been misrepresented to, or withheld from, the market and which undercut or was
inconsistent with the Dell Defendants’ earlier representations and Dell’s earlier reported
financial results, damaging earlier Class Period purchasers of Dell’s publicly traded securities by
billions of dollars. However, Dell’s insiders did not fare so badly. By the time Dell’s publicly
traded securities collapsed, they had pocketed over $3.3 billion in illegal insider trading proceeds
by selling off almost 99 million shares of their Dell stock at artificially inflated prices – before
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the “truth” entered the market. These sales were unusual in timing and amount, dwarfing these
insiders’ stock sales in the months before the Class Period, as shown by the chart set forth below:
INTRODUCTION AND OVERVIEW
6. Dell manufactures and sells computer products, principally PCs, notebook
computers and servers, to large and small businesses and individual consumers. Dell became
successful because of its “Dell Direct” business model, whereby it manufactures or assembles its
own products (it does not “outsource”) and sells them directly to businesses through a dedicated
sales force and to individual consumers over the Internet or by telephone without the benefit (or
cost of) a “middle man” retailer. Using its “Dell Direct” model, Dell grew very rapidly and, by
2002, was selling millions of computers a year – generating annual revenues of over $30 billion.
The key to Dell’s success – especially with consumer and small business customers – was
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effectively, i.e., easily, selling high-quality products and providing very good customer service
and support – both at the time of sale and thereafter. Dell’s consumer and small business
customers did not have a retailer or internal corporate IT department with the expertise or ability
to assist with any start-up or operational problems with the computer they purchased. However,
because historically Dell sold high-quality products and provided high-quality customer service
and support through customer “Call Centers,” staffed with well-trained, permanent employees,
Dell appeared to overcome the disadvantage of a lack of a retail presence to assist with customer
purchase decisions or ongoing operating support. Dell thus achieved success and strong
profitable growth due to its high-quality, reliable products and satisfied customers – many of
whom became repeat buyers due to their favorable experience with Dell and the resulting
excellent reputation of the “Dell Brand.”
7. Notwithstanding this success, Dell, of course, suffered when the 2000-2001 stock
market bubble burst and in the resulting economic downturn. Dell’s stock, which had reached an
all-time high of $60 in 3/00, collapsed to as low as $16.25 in 12/00 and remained depressed for
many months – continuing to trade as low as $16 even in 9/01. This large decline in Dell’s stock
greatly reduced the value of the Dell shares and stock options held by Dell’s top insiders, who
sharply curtailed sales of their Dell stock as that stock fell to low levels. Dell’s executives
wanted to push Dell’s stock higher again, but knew they could do so only by persuading
investors that despite the fact that Dell had now grown into a much larger company, selling
millions of computers each year, with annual revenues of $30 billion by F02,1 it was still capable
of achieving double-digit revenue and strong profit growth – even in an increasingly competitive
environment. For this to happen to the stock, however, it was critical that the “Dell Direct”
1 Dell’s fiscal year ends on 1/31 of each year. Thus, Dell’s F03 year ended on 1/31/03.
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business model appear to continue to excel and for Dell to reduce its ongoing operating expense
levels, as only then could Dell – as a much larger company – continue to achieve strong
profitable growth. During calendar 2002, i.e., most of F03, Dell’s stock price increased back up
to $30 per share. This restored the value of the options to purchase 387 million shares of Dell
stock held by Dell’s executives and managers. By 12/02, these options were at an average
weighted exercise price of $27.09 – making these options worth over $1.2 billion to Dell’s top
insiders.
8. However, in late 2002 and early 2003, Dell’s stock fell again when Hewlett-
Packard surpassed Dell in worldwide computer sales and some analysts questioned Dell’s ability
to successfully compete against Hewlett-Packard in the increasingly competitive PC hardware
market and whether Dell, as a much larger company, could continue to achieve “double-digit”
growth. Dell’s stock fell sharply from over $30 per share back to as low as $22.82 on 2/13/03.
This loss of some $20 billion in market capitalization – an almost 25% fall in Dell’s stock –
wiped out the value of Dell insiders’ 387 million options, as Dell’s stock fell well below the $27
average weighted exercise price of those options, costing Dell’s top insiders over $1 billion, with
the Dell executives named as defendants in this case losing the most. Thus, Dell’s top
executives very much wanted to push Dell’s stock price back up to much higher levels. This
could only be achieved, they knew, by making it appear that the “Dell Direct” business model
was continuing to achieve great success – giving Dell a competitive advantage over other
computer manufacturers and enabling Dell to compete successfully against them – allowing Dell
to report growing profits and profit margins, as Dell successfully eliminated billions of dollars in
annual overhead expenses – without hurting product quality or customer service and support.
9. During the Class Period, which begins on 2/13/03, Dell’s top executives
repeatedly told investors that unlike other companies manufacturing and selling computer
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hardware, Dell alone was achieving strong profitable growth, focusing investors specifically on
its ability to achieve high operating income and operating profit margins and growing EPS,
due to a combination of double-digit sales growth and expense reductions – all fueled by the
continuing success of the Dell Direct model. Dell’s executives told investors they were sharply
cutting Dell’s overhead expenditures, eliminating billions of dollars of annual expense, but doing
so without in any way diminishing Dell’s stringent quality control and component part
inspection and testing procedures or the very high quality of Dell’s computer products or in
any way diminishing the high levels of customer service and support which were indispensable
to the high level of customer satisfaction necessary for the Dell Direct business model to
continue to succeed and for Dell to achieve the sales/revenue growth necessary to produce the
superior financial results it was forecasting.
10. During the Class Period, the Dell Defendants also told investors that Dell was
uniquely well positioned to benefit financially from the well-known phenomenon of declining
component part prices in the computer hardware manufacturing business. This was because
Dell’s “build to order” operation allowed it to operate with an extremely small amount of
component part inventories – frequently just three or four days supply. Thus, Dell’s model
enabled it to very quickly capture and benefit from any decline in component part prices, while
avoiding the risk of being caught with large amounts of outmoded or over-valued component
parts. Dell frequently attributed its superior financial results, including its improving operating
margins, to its ability to successfully capture and benefit from declining component part prices.
11. During the Class Period, the Dell Defendants made specific positive statements,
as summarized below, and detailed by date and speaker later in this Complaint:
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Direct Business Model
(a) Dell had a unique direct-to-customer business model, whereby it
manufactured or assembled its own products (i.e., it did not “outsource”) and sold them directly
to customers over the telephone or Internet (i.e., it did not use “middlemen” or retailers). This
direct model supposedly provided Dell with competitive and cost advantages over other
computer manufacturers/sellers. The successful operation of Dell’s “direct” model was so
important to analysts who followed the Company that the model and its current state of
performance was discussed in every quarterly or annual SEC filing by Dell and virtually every
conference call or analyst presentation involving Dell’s CEO or Chairman during the Class
Period. Thus, the Dell Defendants consistently stressed the “success” of Dell’s “industry-
leading business model,” making very positive statements, like:
• “[O]ur business model is structurally advantaged.”
• “[W]e continue to demonstrate a focused model that is structurally advantaged and drive[s] leading financial operating performance and . . . leading shareholder value creation.”
• “[T]he [Dell Direct] business model is . . . the key advantage we have compared to our competitors.”
• “The Dell [Direct] model . . . is uniquely able to offer the highest quality products.”
• “Dell [continued] its direct-to-customer model to drive down costs.” “Dell’s low-cost structure and efficient direct-to-customer model have enabled the company to consistently . . . maximiz[e] operating profitability. . . . Dell’s model inherently provides cost advantages in manufacturing, operations, and its supply chain.”
• “[O]ur cost [advantages allow us] to drive . . . profitable growth. . . . Our advantage business model . . . allows us to continue to drive superior results.”
• “Our model consistently delivers growth in all products and regions which is accretive [to] shareholder value.”
• “Dell’s . . . direct-to-customer model [has] enabled the company to consistently . . . maximiz[e] operating profitability. . . . Our model is structurally advantaged, . . . enabling us to consistently deliver exceptional financial and operating performance in all environments.”
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• “Our U.S. consumer business has achieved tremendous success . . . – driven by the strength of the direct model, superior customer value, and increasing . . . loyalty among our customers. This success is evidenced by our strong operating results.”
• “[D]ell’s business model is advantaged in all environments across all regions and in all product categories. . . . These advantages enable Dell to continue to post solid profits and rapid growth, regardless of the prevailing market conditions.”
• “[T]he strength of Dell’s direct-to-customer business model . . . makes Dell better positioned than its competitors to profitably grow market share in any business climate.”
• “Dell’s growth capabilities [and] advantages tend to strengthen in slower growth environments. . . . Dell’s model can thrive even in periods of slower component declines given Dell’s ability to manage its business.”
• “[Dell] almost cheers when demand slows as Dell’s strengths become accentuated.”
• “The Dell model is winning, our growth strategy is progressing as planned. . . . [Dell was] very well positioned for the future.” “[Dell has] demonstrated the fundamental advantages of [its] high-quality, low-cost business model.”
• “[U]tilizing the advantages of the Dell model . . . will allow [Dell] to continue to outpace the industry. . . .” “[Dell’s] model is performing well, the model is solid . . . [and] will continue to be very successful.”
Superior Quality Products
(b) The Dell Defendants also frequently stressed that Dell’s owned/controlled
manufacturing factories and the quality control and testing procedures it maintained for
component parts and finished goods assured the highest quality products, which, combined with
Dell’s superior customer support and service, was a key to the success of the Dell Direct model.
For instance, the Dell Defendants made positive statements, like:
• “We owner-operate our factories. Driving efficiencies through global scale and proprietary practices that can only be realized by owning manufacturing operations.”
• “We continue to reaffirm the tenets of our direct model: direct customer relationships, information over inventory, world-class manufacturing . . . excellence.”
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• “Dell’s manufacturing process consists of assembly, . . . functional testing, and quality control. Testing and quality control processes are also applied to components, parts, and subassemblies obtained from third-party suppliers. Quality control is maintained through the testing of components, subassemblies, and systems at various stages in the manufacturing process. Quality control also includes a burn-in period for completed units after assembly, on-going production reliability audits, failure tracking for early identification of production and component problems, and information from Dell’s customers obtained through services and support programs.”
• “Dell’s business strategy combines its direct customer model with a highly efficient manufacturing . . . organization. . . . This . . . enables Dell to provide customers with . . . high-quality . . . products.”
• “No other technology company can rival Dell’s know-how [in] delivering . . . technologies that meet or exceed customer expectations.”
• “We continue to provide our customers with the highest-quality products.” “Dell offers . . . high-quality technology . . . and standing behind the product with leading customer service and support. As a result, . . . consumers are indicating an increasing level of broad preference for Dell.”
• “[O]ur products were recognized by industry experts for their quality.”
• “Dell is studied by customers worldwide for its expertise in manufacturing. . . . Process improvements benefit Dell and customers through lower costs, better quality and better overall customer experience.”
• Dell’s manufacturing included testing and quality control processes to component parts obtained from suppliers and was maintained throughout the manufacturing process – including a burn-in period for completed units and ongoing product reliability audits and failure tracking for early identification of problems.
• While Dell was cutting billions of dollars annually in its manufacturing costs, “lower cost doesn’t mean lower quality” – regarding tradeoffs between cost and quality of components, “Dell’s focus on driving down cost does not mean that there are quality tradeoffs.”
Customer Service and Satisfaction
(c) In addition to the “highest” product quality, another indispensable part of
the success of the Dell Direct model was a high degree of customer satisfaction provided by
Dell’s customer support and service, which Dell assured investors it monitored constantly, and
admitted was “a key performance metric for the company” and the key to its ongoing revenue
growth, i.e., volume. During the bulk of the Class Period, Dell represented its customer support
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and service operations were performing very well, yielding strong – indeed increasing –
customer satisfaction, which was fueling Dell’s strong revenue growth and would drive
profitable growth going forward. For instance, the Dell Defendants made positive statements
like:
• “Product leadership helps attract new customers to Dell. But their subsequent experience is critical to returning again and again.”
• “At Dell, an exceptional customer experience begins with product leadership. And it continues long after the sale as we strive to instill satisfaction, trust and loyalty with each customer contact. Sustaining that continuum has been integral to our success.”
• “We’ve always known that volume and market-share numbers are expressions of customer experience and satisfaction. We regularly assess ourselves against a broad range of customer-focused measures, including the timeliness with which we deliver built-to-order systems, the reliability with which they perform, and the speed and quality of service and support.”
• “Meeting unique customer requirements is our responsibility and commitment. . . . [T]hose requirements follow simple themes: provide quality products and services, resolve issues when they arise, and show customers how highly they’re valued at Dell. For each of those areas, we persistently track and act in response to how customers say we’re performing against a variety of specific standards.”
• “We regularly measure our performance from the customer’s perspective. As examples, we track how easy it is to contact Dell, the accuracy with which orders are fulfilled, if deliveries are on time, overall product quality, whether we correct an issue the first time, and if our customers are treated with courtesy and respect.”
• “A key component of our success and our ongoing strategy has been our commitment to the highest quality of service and support. Dell has consistently rated among the best in the industry at providing service and support to customers.”
• “Dell’s . . . direct customer model . . . enables Dell to provide customers . . . with products and services that are easy to buy and use.”
• “[W]e made significant progress . . . [in] product leadership . . . creating an exceptional customer experience . . . . Improvement in those areas is helping expand our competitive advantages and sustain superior operating results for the long term.”
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• “Respondents to a recent survey . . . ranked Dell No. 1 in customer satisfaction . . . for the fifth consecutive year.”
• “Dell earned more than 100 awards for product and service quality and reliability last year alone. . . . Technology Business Research ranked Dell No. 1 for overall service and support among hardware vendors, and first in customer satisfaction.”
• “[I]n a recently completed Harris survey, 83% of customers were either satisfied or very satisfied with buying consumables direct from Dell, versus 66% being satisfied who bought through retail.”
• “A commitment to high customer satisfaction . . . has enabled Dell to extend its lead as the world’s No. 1 provider of personal computer systems.”
• “We improved Dell’s overall customer experience considerably in fiscal 2006.”
Successful Cost-Cutting Efforts
(d) As a key part of showing growth in its operating profit margin and
reduction of Dell’s operating expenses measured as a percentage of revenue, during the Class
Period Dell was implementing a huge cost-cutting program to eliminate billions of dollars in
annual corporate operating expenses, including reducing its number of manufacturing facilities
and people employed in these operations and providing customer support and service from “cost
effective” locations, while, by producing “higher” quality products and generating “increasing”
customer satisfaction, actually reducing product warranty costs. These steps were supposedly
successfully boosting Dell’s operating margins and profits without undermining the high quality
of products and high level of customer support and service necessary for the Dell Direct model to
succeed. For instance, the Dell Defendants made positive statements like:
• “And we’re still focused on a lot more cost savings. We talked in the last year about $1 billion of cost savings as a target. We achieved that target; we’re pushing for even further cost savings. . . . [Y]ou can see the impact that had on us being able to expand our margins and our operating income.”
• “Though our advantage is significant across all product categories and in all market environments, and we will continue to widen the gap with our competitors, we have removed over $3 billion from our cost structure over the past two years and are on track to remove about $1.5 billion in cost this year and have identified additional cost savings to take us well into the future.”
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• “Last year, we succeeded in reducing our cost structure by over $1.2 billion. . . . [W]e exceeded our initial expectations. . . . We have identified even more cost savings for fiscal year ‘04. . . . [W]e also expect to significantly reduce our warranty costs . . . [to] optimize operating income and improve operating income margins.”
• “[W]e have been able to reduce our costs by about $1.2 billion during this past year. We have targeted even more for this year that we have started. And looking at our cost savings over the past two plus years, or the past two years plus the current year, we expect to realize a little over $3 billion in savings.”
• “We took our operating expenses down to a record low of 9.9, down below 10 percent of revenue.”
• “[W]e were . . . able to improve our operating margins. . . . [O]ur focus on operating expenses, took that down to a record low 9.7% of revenue which drove operating income dollars to new records – $3.5 billion dollars. . . . This cost-saving element is something that we just can’t focus on enough. . . . We first gave out targets a couple years ago, since that time we generated about $4 billion of cost savings.”
• “Dell maintained its record low operating expenses as a percentage of net revenue of 9.6%, compared to 9.8% in the same quarter last year . . . primarily [as] a result of cost reduction initiatives.”
• “As part of management’s focus on striving to improve margins, Dell remains committed to reducing . . . manufacturing costs, warranty costs . . . and overhead or operating expenses. These cost saving initiatives also include providing certain customer technical support . . . from cost effective locations.”
• “[I]n these last three years, we’ve actually reduced the number of manufacturing facilities [and] reduced the number of people that are involved in the manufacturing process. . . . So, it’s put us in a position to take our manufacturing costs down significantly. . . . Another category is warranty. . . . Very focused on improving [product] quality, which, over time, also reduces our warranty costs, our experience is much better. Our warranty costs on notebooks and desktops over the last three years have declined about 50%.”
• “Dell leveraged its low-cost structure and efficient direct-to-customer model to aggressively price and pass through declining component prices and structural savings. . . . Gross margins increased . . . as a result of Dell’s cost reduction initiatives and component cost declines. Dell’s continued focus on cost control also resulted in record-low operating expenses . . . . The Dell model excels in any macro-economic environment.”
• “The year-over-year improvement in gross margin occurred primarily as a result of Dell’s cost savings initiatives and declining component costs. As part of its focus on improving margins, Dell remains committed to . . . improv[ing]
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profitability through four primary cost reduction initiatives: manufacturing costs, warranty costs . . . and overhead or operating expenses.”
• “Another difference is that our cost savings is really generated from what we think are much more sustainable activities. . . . [O]ur cost savings are somewhat proprietary.”
• “Manufacturing efficiency and a very lean operating cost structure . . . [t]hese cost advantages are structural, inherent to our model, and accrue uniquely to Dell.”
• “The year-over-year improvement [in gross margins] was primarily driven by Dell’s cost savings initiatives. As part of management’s focus on improving margins, Dell remains committed to reducing . . . manufacturing costs . . . warranty costs . . . and overhead or operating expenses. These cost savings initiatives also include providing certain customer technical support . . . from cost effective locations.”
• “Dell’s focus on driving down costs does not mean that there are quality tradeoffs.”
Intel Relationship
(e) Throughout the Class Period, Dell affirmed the benefits and success of its
continuing reliance on Intel as its sole source of supply of microprocessors as it was reported
that:
• “Dell considered changing that practice as AMD products became more competitive and Intel suffered a series of technical slip-ups last year. But Intel . . . has improved its ‘roadmap’ of new products, to the point that Dell probably won’t change its Intel-only purchasing policy.”
• “Dell sticks firmly to Intel. Hewlett-Packard . . . offers . . . computers similar in virtually every detail except their microprocessor. Customers can choose machines with Intel processors or similar models with chips from [AMD].”
Record Financial Results
(f) Purportedly as a result of Dell’s execution of its unique and highly
successful Dell Direct business model, Dell consistently reported record or near record profits
during the Class Period, extolling these results as validating the success of its Dell Direct model,
higher product quality, superior customer support and service and its success in cost-cutting
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without compromising quality and service. For instance, the Dell Defendants made positive
statements, like:
• “Performance . . . has been exceptional in a tough environment, and . . . it just speaks volumes to what we think we have with our model. . . . [W]e have been able to . . . improve the operating performance of the company by over 100 basis points.”
• “We made our guidance in each and every one of the last eight quarters – we have met or exceeded the guidance that we have given out. It’s a very strong, consistent performance. We set records for . . . operating income, opex as a percent of revenue.”
• “[W]e hit our targets again. Marking the twelfth consecutive quarter in which we have met or exceeded our guidance to investors. And we generated record . . . operating income and [EPS].”
• “[F]iscal year 2004 . . . was the most successful in our 20-year history. We’ve achieved record-breaking figures in some of the key areas of the company, including unit shipments, revenue, operating and net income and [EPS].”
• “In fiscal 2006, Dell continued to outpace the industry . . . – achieving company records for . . . operating income and [EPS].”
• “Each milestone resulted from the global execution of our direct business model.”
• “This past year, we achieved record . . . operating income . . . all in a down year for the industry, further differentiating Dell from our competitors.”
• “Dell’s exceptional performance again demonstrated the superb . . . execution of a better way of doing business . . . . Our business is a model for customer focus, growth and profitability. We ended the year well ahead of our plan to achieve annual revenue of $60 billion by the end of fiscal 2007.”
• “Dell outperformed the market again . . . improving profit margins. [O]ur year-over-year revenue . . . and earnings growth significantly outpaced the market. . . . We delivered improved profitability as operating margins increased by another 10 basis points.”
• “Dell has consistently outperformed the market in all competitive environments and continues to do so . . . . Specifically, ours year-over-year earnings growth significantly outpaced the market. While we believe industry . . . revenues were down 5% year-over-year, sales revenue grew by 18%. We delivered improved profitability as operating income dollars grew by more than 37 percent year over year.”
• “And we delivered improved profitability as operating income dollars continue to grow faster than revenues. We delivered 24 cents in [EPS], up 26% year-over-
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year, a $9.8 billion in revenues. . . . [W]e achieved an expense ratio of 9.6%, the lowest in company history. Operating income margins increased 10 basis points sequentially and 60 basis points year-over-year to 8.6%, despite challenging market conditions.”
• “‘[O]nly Dell simultaneously creates . . . rapid growth and solid profitability.’ . . .”
• “We have grown our operating profits by more than 50% over the last two years.”
• “[W]e posted record revenue with double-digit growth . . . with enhanced overall profitability. Quarterly operating income was in excess of $1 billion, a company record. We delivered improved margin sequentially . . . . [EPS] increased 29%, over-achieved on EPS hitting 31 cents. We improved our operating margin . . . by over 20 basis points sequentially to 8.6%.”
• “We leveraged the unique strengths of our model to deliver enhanced profitability and record performance across our business. [O]perating and net income [and] EPS . . . were all company records.”
• “Dell delivered strong performance and records across the board, including . . . operating income [and] EPS.”
• Dell’s full-year “revenue, operating profits and [EPS] were all company records.”
• “Our results reaffirm the strength of the model . . . allowing us to continue to outperform the industry.”
• “[W]e’re probably better positioned, financially than we certainly have been in any other point in time in this company’s life.”
• “It’s clear that our ability to generate superior returns remains unmatched.”
High Quality of Financial Results
(g) Not only did Dell consistently report record operating results during the
Class Period, it stressed the integrity of those financial results, with the Dell Defendants making
positive statements like:
• “[W]e’re winning the right way, with a high level of integrity.”
• “Dell’s quality . . . of earnings continues to lead the market as we turned in yet another quarter of strong revenue and earnings growth.”
• “[T]he consistently high quality earnings and industry leading returns generated by our business model and focused strategy.”
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• Dell’s internal financial, accounting and disclosure controls had no significant deficiencies and there was no undisclosed fraud ongoing at Dell, material or otherwise.
Forecasts of Future Growth
(h) As a result of these very positive representations throughout the Class
Period, the Dell Defendants repeatedly made forecasts of strong revenue and profit growth going
forward, which were not protected by the Private Securities Litigation Reform Act of 1995’s
(“PSLRA”) forward-looking statement provisions.
12. PWC reviewed Dell’s 10-Q and 10-K filings with the SEC and the financial
statements therein; it also reviewed Dell’s internal financial accounting and disclosure controls
and audited and certified its annual financial statements (F03, F04, F05) issued during the Class
Period, representing it had performed its audits under Generally Accepted Auditing Standards
(“GAAS”) and that the financial statements complied with Generally Accepted Accounting
Principles (“GAAP”) and fairly presented Dell’s financial condition and results from operations.
13. As a result of Dell’s strong financial results and the Dell Defendants’ repeated
positive statements and presentations during the Class Period, many securities analysts issued
very positive reports on Dell, reporting and/or repeating what the Dell Defendants had said
publicly or told them in meetings, praising the effectiveness of the Dell model, forecasting strong
growth in revenues and improvements in profit margins and EPS and recommending the
purchase of Dell shares. For instance:
• 2/13/03 – Thomas Weisel Partners: “Margin trends solid. The gross margin was strong at 18.3% and was 20bp above our estimate. Dell continues to manage expense effectively, with operating expenses of 9.9% . . . matching its all-time low. The end result was an operating margin of 8.4%, which as up 10bp sequentially . . . . Dell continues to focus on reducing costs, and management noted that the company exceeded its goal of $1bn in cost reduction for FY03 and that it can exceed that number for FY04.”
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• 2/14/03 – Needham: “Dell reported a picture perfect quarter. . . . The company’s operating margin continued its steady upward progression to 8.4% from 7.4% a year ago.”
• 4/3/03 – Deutsche Bank: “Overall tone was very upbeat, with mgmt highlighting . . . [that] Dell’s business model is structurally advantaged to deliver better financial & operating performance . . . . We continue to believe Dell is the best-positioned PC company based on the efficiencies of its direct model . . . .”
• 5/28/03 – Bear Stearns: “Consumer ‘Going Gangbusters’: COO Kevin Rollins was very upbeat about Dell’s performance and outlook in its consumer efforts saying that the consumer business is profitable, growing, and its brand is strengthening. . . . Component Basket Still Trending Down: . . . Overall, Dell noted that the rate of component declines is slightly less than the prior quarter but the overall basket is still trending down. . . . Lower Cost Doesn’t Mean Lower Quality: Speaking about the tradeoffs between cost and quality of components, Dell noted that Dell’s focus on driving down cost does not mean that there are quality tradeoffs . . . .”
• 8/15/03 – J.P. Morgan: “The company is resoundingly confident about its market strategy in PCs and servers, and Dell also continues to trumpet its sterling cost structure advantage.”
• 8/18/03 – Neeham: “Dell reported another picture perfect quarter . . . .”
• 10/9/03 – UBS: “Dell also reaffirmed that it can expand its operating margins to 10% (from 8.5% currently) and was even ahead of plan . . . . Dell believes that there are four areas for cost reductions . . . lower warranty costs . . . [including] improving call center efficiency, and lowering fixed costs and . . . structural cost improvements . . . .”
• 4/8/04 – Deutsche Bank: “Throughout the presentations, management highlighted the company’s structurally advantaged business model and showed how it compared favorably with its peers from a profit, growth, and industry positioning perspective.”
• 4/8/04 – Prudential Equity: “Most of the presentations were top level in nature, with mgmt touting the benefits of the direct model . . . . Most significant were mgmt’s comments that the company is tracking ahead of its goal for $60B in revenue in FY07.”
• 7/1/04 – J.P. Morgan: “We met with Dell’s CFO, James Schneider, yesterday. . . . [T]he tone of the meeting was positive. Growth expectations remain intact . . . . Dell remains optimistic about its growth prospects . . . .”
• 8/12/04 – Thomas Weisel Partners: “Execution separates Dell from the pack. . . . [G]ross margin of 18.2%, operating margin of 9.0%, and EPS of $0.31 were all exactly in line with our and Street estimates. . . . Gross margin improvement due mainly to decline in component prices – leading to EPS upside.”
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• 8/13/04 – Bear Stearns: “Why is Dell doing well? Primarily due to its advantaged, direct model which keeps it close to customers [and] provides lower costs . . . .”
• 8/17/04 – CSFB: “Outlook. We believe Dell owns a sustainable competitive advantage due to its direct model, and we expect the company to deliver superior growth and attractive financial returns in the foreseeable future.”
• 11/12/04 – Piper Jaffrey: “Robust growth across every segment and a declining component cost environment enabled the Company to meet both our and consensus estimates of $12.5B and $0.33. Gross margins of 18.5% beat our estimates . . . . Our takeaway from the earnings report and conference call is that the Dell revenue and earnings growth trajectory has not slowed and shows no signs of slowing in the near future. The Company indicated that it was executing ahead of plan to achieve $60B in annual revenues . . . . The Dell model continues to outperform . . . .”
• 11/12/04 – CIBC: “Controversy regarding the sustainability of Dell’s margins and growth rates, underlying our prior Sector Performer rating, should take a back seat following bullish guidance on strength of end-markets, and on Dell’s ability to maintain its market-share momentum. . . . Overall, with gross margins on an upswing, and next-round scalability of operating margins (after 40 bps gains this year) probably no more than nine months away, evidence suggests that tailwind of declining component prices is in fact allowing Dell to execute on its lean inventory and dynamic sourcing models.”
• On 12/9/04, S.G. Cowen: “We hosted Dell CEO Kevin Rollins at a Boston investor lunch meeting yesterday. It seems apparent that the Dell execution engine is running essentially on all cylinders. Current demand is strong . . . . We are raising estimates . . . .”
• 1/7/05 – Bear Stearns: “After meeting with Dell management . . . our takeaway was that Dell continues to be a solid growth story . . . driving strong revenue growth and with potential for margin expansion over time. CEO Kevin Rollins noted Dell’s confidence in 17%-20% revenue growth range in the foreseeable future.”
• 2/10/05 – Bear Stearns: “[I]t was a typical Dell quarter (16th in a row in line or above expectations), highlighting Dell’s above-average, profitable growth . . . . [M]anagement was confident that its growth trajectory was intact . . . . We’re raising our estimates for FY06 from $1.58 to $1.60 in EPS (vs. $1.28 in FY05) . . . and for FY07 from $1.85 to $1.90 in EPS . . . . Gross Margin Above Expectations. Gross margin of 18.5% was above our forecast of 18.4%, up 5 basis points sequentially and 20 basis points from the year-ago period, owing to . . . more favorable component cost declines . . . .”
• 4/7/05 – Bear Stearns: “Dell was confident about its prospects to drive growth during its analyst day . . . . [C]onfident about growth prospects. . . . CEO Rollins
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came across confident about Dell’s ability to drive growth . . . . Dell’s Model thrives in a slow-growth environment. Though CEO Rollins signaled a more cautious environment, he noted that Dell’s growth tends to be faster in periods of slower market growth given its low-cost, share gain model.”
• 6/6/05 – Bear Stearns: “We hosted a dinner with Dell CEO Kevin Rollins . . . . Rollins highlighted Dell’s growth capabilities in all markets, indicating its advantages tend to strengthen in slower growth environments . . . . Rollins noted that he almost cheers when demand slows as Dell’s strengths become accentuated . . . .”
14. During 2003-2004 and through 8/05, as Dell consistently reported extremely
strong – often record – financial results, with double-digit growth in revenues, accompanied by
declining operating expenses as a percent of revenues – yielding strong operating profits – all
purportedly due to Dell’s “flawless” or “superb” execution of its Dell Direct model –
accompanied by the false statements summarized above – with continued growth and profit
improvement forecast for the future. As a result, Dell’s common stock recovered dramatically
from its late 2002 decline, sky-rocketing higher from a low of $22.82 on 2/13/03, at the
beginning of the Class Period, to as high as $42.57 by 12/9/04. The stock continued to trade at
as high as $41 through 8/05. As Dell’s stock became artificially inflated and traded at these
inflated levels, this restored the value of the Dell insiders’ stock options. And Dell’s insiders
took advantage of this stock price inflation with a vengeance. Between 2/03 and 9/05, Dell’s top
insiders unloaded almost 99 million shares of Dell stock they owned, pocketing $3.3+ billion
in illegal insider stock sales proceeds. As the chart below shows, executives sold off gigantic
amounts of their stock – with all but Michael Dell (“M. Dell”) selling 70%-100% of the Dell
stock they actually owned and were capable of selling. Even M. Dell, the founder and largest
holder of Dell stock, sold off 27% of his ownership stake in the Company.
Defendant
Position Shares Sold Proceeds % of SharesSold Owned
Michael Dell CB/CEO 85,138,000 $2,829,813,460 27% Kevin Rollins President/CEO 2,163,000 $74,192,846 99%
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Joseph Marengi SVP-Americas 1,543,664 $55,197,246 100% John Medica SVP-Products 809,956 $31,315,764 99% Rosendo Parra SVP-Americas 1,458,953 $51,266,953 88% James Schneider CVP-CFO 1,686,000 $57,838,699 99% William Amelio SVP-Asia 1,024,281 $40,067,747 93% Jeffrey Clarke SVP-Products 963,815 $35,207,325 97% Robert Davis CAO 196,556 $7,247,401 96% John Hamlin SVP-Global Online 869,443 $31,336,831 99% Thomas Green SVP-Law/Secretary 384,000 $12,453,120 70% Glenn Neland SVP-Procurement 169,000 $6,675,330 98% Martin Garvin SVP-Procurement 90,500 $3,666,680 100% Randall Mott SVP-CIO 370,000 $14,769,800 74% Michael Miles Director 1,428,000 $51,276,720 73% Donald Carty Director-Audit Chair 564,150 $20,128,490 73%
TOTAL: 98,859,318 $3,322,454,411
The sell-off of $3.3+ billion in inflated stock – oftentimes over 90% of the insiders’ holdings – is
the largest insider bail-out in the history of any U.S. public company. This “pump-and-dump”
was accomplished by defendants’ dissemination of false and misleading statements to artificially
inflate Dell’s stock price and then spending over $12 billion of Dell’s corporate funds to
repurchase 350 million shares of Dell common stock on the open market as they were selling,
thus using Dell’s corporate funds to help manipulate the market price of the stock while they
bailed out – in effect, using corporate money to fund the purchase of the shares – mostly stock
option shares – they were selling. Why – if Dell’s business was actually performing as
wonderfully as the Dell Defendants said it was and if its future prospects were as good as they
forecast they were – would these insiders sell off so much of their stock? The Dell Defendants’
insider selling was unusual in timing and amount, vastly exceeding their stock sales in the 16-17
months before the Class Period, as shown on page 5.
15. In 3/05, a series of company-specific negative revelations began regarding Dell
which were inconsistent with, undercut and contradicted the Dell Defendants’ prior Class Period
positive representations. First came revelations from the Japanese antitrust officials of Intel’s
apparently illegal practice of paying large secret end-of-quarter rebate/kickback payments to
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computer OEMs like Dell in return for exclusive or near-exclusive relationships – payments
which boosted the OEMs’ reported operating profits and margins. Then, a customer revolt – fed
by the emerging Internet blog system – began in 6/05-7/05. It gave widespread circulation to
consumer nightmares in dealing with computer purchases and computer support and service
issues with Dell and received increasing publicity in the mainstream financial media, indicating
that Dell’s vaunted direct sales method and product quality had decreased markedly and its
customer service and support operations had collapsed. Reports of failures to honor advertised
sales terms or to provide products with promised features and refusal to honor warranties became
widespread. Defective PC motherboards (capacitors) and lithium batteries created widespread
performance problems – even failures and fires – with Dell computers. Dell’s call centers – now
manned by thousands of fewer personnel, more and more located in India, the Philippines or
other non-U.S. locations, most of whom were ill-trained, part-time workers – disconnected
customers, made them wait on hold for long times (even up to and over an hour), repeatedly
transferred their calls without solving the customers’ problems, refused to even address
Microsoft software issues and refused to honor customer service expectations, rigidly enforcing
Dell’s new, restrictive consumer warranty policies which had shortened the time and breadth of
coverage, implementing Dell’s new “fix on fail” only policy. This resulted in an upsurge in
customer outrage and dissatisfaction which hurt Dell’s sales, not only with potential repeat
customers, but, as adverse publicity spread, with new ones as well.
16. In addition, in mid-8/05, Dell began to report financial results falling short of its
previously forecasted levels of performance, initially with revenue growth and operating
profits/income shortfalls – and ultimately – operating income, operating margin and EPS
declines! However, rather than comply with their obligations under the federal securities laws
and make truthful and complete disclosure, Dell’s insiders opted instead for partial disclosures
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accompanied by false reassurances that sought to and did conceal the true nature and extent of
the problems Dell was encountering – the increasing defects with its products and its inability to
fix its customer support and service operations, which it represented were being remedied with
improving customer satisfaction. Also, Dell continued the falsification of its financial results
which had been going on throughout the Class Period, continuing to report inflated operating
profit margins, operating income, net income and EPS, while understating is warranty
expense. As a result, while Dell’s stock began to decline in 7/05, the stock continued to trade at
artificially inflated levels until a series of company-specific negative revelations in 7/06-8/06.
Then Dell reported massive financial shortfalls due to continuing customer outrage and
dissatisfaction, exacerbated by the massive spending cuts Dell had engaged in in the past few
years to artificially boost its current period profitability, which was negatively impacting the
revenue and profit growth, and the loss of hundreds of millions of dollars a year in secret (and
possibly illegal) rebates/kickbacks Dell had been receiving from Intel to boost its reported
operating profits and margins. Dell also revealed an SEC investigation into its financial
reporting practices (which Dell had known about but concealed for a year), and that Dell itself
had “discovered” internal financial irregularities and misreporting – all resulting in Dell’s
inability to file current financial statements with the SEC/Nasdaq. Dell also admitted that, as a
result of these business and financial reversals, it would be required to boost corporate spending
by hundreds of millions of dollars and hire almost 10,000 additional employees in an effort to
restore its business so that it could more successfully compete with competitors that were selling
higher quality, more attractive products, often through retailers who supplied otherwise superior
customer service and support. On 9/11/06, defendants disclosed Dell would not be able to file its
interim financial report for the 2ndQ F07 and that it had received a subpoena from the U.S.
Attorney for the Southern District of New York requesting information on Dell’s financial
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reporting practices back to 2002. As a result of the collapse of Dell’s business model and
operations, Dell’s net income in F07 will be almost $1 billion less than in F06, its future growth
prospects are much worse than were represented during the Class Period and its stock has fallen
sharply from its Class Period highs. Finally, Dell’s CFO Schneider resigned as the SEC
investigation escalated and it has been publicly reported that European Union investigators have
recommended that the European Antitrust Commission formally charge Intel with illegally
thwarting any competition in the computer chip market due to the “exclusivity” discounts
provided PC manufacturers, including Dell. On 1/23/07, Dell revealed that it is unlikely to meet
the requirements for continued listing on Nasdaq due to its inability to file current financial
statements.
17. As the Class Period was ending and thereafter, M. Dell and Rollins and other Dell
insiders had to admit the terrible problems that had been plaguing Dell’s business during the
Class Period:
• Regarding cutting call center costs and switching from full-time to temporary, part-time employees: “we made those decisions that work with the short-term, but they were really damaging to us over the long-term.”
• “[O]ur customer satisfaction did come down . . . because we cut back there.”
• “[O]ur customer support declined. . . . The problems were of our own making and we can’t blame them on the market.”
• “The team was managing cost instead of managing service and quality. . . . It’s totally the wrong answer.”
• “We over-estimated Intel and under-estimated AMD.”
• “We were doing some things that were just plain wrong.”
• “[W]e have been pretty open about admitting the various mistakes we have made.”
During the Class Period, the following material adverse facts were known or recklessly
disregarded by the Dell Defendants, who concealed these facts from investors:
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(a) The Dell Direct business model was not operating successfully or creating
the strong, often record, financial results and operating margins Dell was reporting; in fact, due
to overly aggressive cost-cutting in Dell’s customer support and service and manufacturing
operations, Dell’s business model was being afflicted with sky-rocketing customer
dissatisfaction and complaints, as well as increasing product quality problems (especially with
laptop batteries and capacitors). In truth, Dell’s financial results were being falsified and
temporarily inflated by (i) large cost-cuts which would have to be reversed and remediated; (ii)
improper accounting tricks and contrivances, including under-accruing warranty costs and failing
to take timely write-downs for defective products and product replacement; (iii) its secret receipt
of some $200 million per quarter in rebate/kickback payments (e-CAP payments) from Intel in
return for exclusively purchasing Intel microprocessors/chips; and (iv) manipulation of Dell’s
warranty reserves to understate the required reserve.
(b) Dell was not manufacturing or selling the highest quality products, as
Dell’s aggressive cost-cutting in its manufacturing operations to boost its reported profits in the
short term had badly weakened Dell’s quality control procedures and standards for component
parts, i.e., batteries and finished goods, such that Dell was encountering an upsurge in customer
complaints due to faulty products, including capacitor failures, motherboard failures and
widespread laptop (lithium) battery defects.
(c) Dell did not have an unrivaled ability to create products or technologies
that met or exceeded customer expectations, nor did it have world-class manufacturing
excellence, producing high-quality products. In fact, as a result of the aggressive cost cuts in
Dell’s manufacturing operations, Dell’s quality assurance procedures had become badly
impaired, leading to a marked decline in product quality.
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(d) Dell’s cost-cutting program was resulting in a marked increase in the
production of defective products which did not meet Dell’s historic quality standards and a
marked decline in Dell’s historic levels of customer support and service and thus customer
satisfaction, which Dell insiders knew would cost hundreds of millions, if not billions, of dollars
to remedy, including the hiring of thousands of additional full-time employees to be trained to
staff customer call centers and to improve Dell’s quality assurance techniques and practices in its
manufacturing operations.
(e) In order to cut operating costs, Dell had sharply curtailed its quality
control processes by no longer testing component parts (specifically batteries, hard drives,
optical drives or motherboards and laptop accessory parts, including power adaptors) received
from suppliers. Rather, Dell was relying on post-assembly quick tests of completed units to
discover defective component parts. In addition, it had also curtailed the post-assembly “burn-
in” testing of units, which steps in combination were resulting in Dell shipping much larger
numbers of computers with defects and performance problems, leading to increased quality
problems and customer dissatisfaction.
(f) Dell was not providing superior customer service and support as, due to
overly aggressive cost-cutting activities in Dell’s customer support and service operations to
boost its reported profits in the short term, including moving most of Dell’s consumer and small
business customer support and service call centers to India and the Philippines and replacing full-
time, well-trained employees with part-time, ill-trained (but cheaper) employees, Dell’s customer
support and service operations were badly impaired, resulting in very long wait times and an
inability to adequately respond to customer complaints and questions, generating an upsurge in
customer anger and dissatisfaction with Dell, its products and its customer support and service,
which Dell’s internal metrics showed would hurt sales.
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(g) Because of its shifting of much of its customer support and service
operations, especially for its consumer and small business customers, to “call centers” in India
and the Philippines and staffing its call centers with part-time, poorly trained employees, Dell
was no longer providing a superior customer experience or generating high degrees of (or
improving) customer satisfaction. Rather, Dell was encountering a widespread customer revolt
with a massive upsurge in complaints regarding declining product quality and declining service
and support operations and a sharp decline in one of Dell’s key internal metrics – the “likely to
repurchase” number.
(h) The Dell Direct model also was not functioning effectively with respect to
Dell’s direct sales process because Dell had flooded the market with a huge number of confusing
and contradictory promotional offers which its now ill-trained and inadequate sales force was
unable to effectively process. This was leading to refusals to honor many “coupons” and
“promotions,” resulting in customer dissatisfaction and refusal to buy Dell products, which was
showing up in an important internal Dell metric known as the “likely to repurchase” number,
where Dell was seeing soaring negative sentiment which meant customers were displeased with
the Dell sales process and thus Dell’s sales growth would decline.
(i) While Dell publicly disseminated favorable surveys and reports purporting
to show high degrees of Dell customer satisfaction with product quality and service and support,
in fact, its own internal surveys, information and customer metrics (which it constantly
monitored) showed a huge upsurge in customer dissatisfaction with and anger at Dell, including
a measurable increase in negative responses to its most important metric, the so-called “likely to
repurchase” number, which Dell knew indicated serious problems with ongoing sales growth.
(j) Dell’s increasing product quality was not resulting in a decrease in Dell’s
warranty costs; in fact, Dell had quietly curtailed the length of its product warranty and sharply
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curtailed the breadth of its warranty coverage (it had eliminated the computer operating system
from its warranty) for individual consumers and small businesses and, in addition, had secretly
adopted a new “fix-on-fail-only” policy whereby it would provide in-home repair service or
product replacement only when a computer (or component) completely failed, as opposed to
merely malfunctioned, to cut costs. However, these severe restrictions in Dell’s warranty
coverage and service to its customers – which was much different than Dell’s historic “customer
friendly” approach to warranty, service and product quality issues – were causing an upsurge in
customer dissatisfaction with and anger at Dell, which Dell insiders knew would inevitably result
in declining sales growth and a massive increase in warranty and product repair costs to try to
restore customers’ satisfaction to acceptable levels.
(k) From 8/05 on, the SEC had notified Dell it was investigating Dell’s prior
financial reporting practices and SEC filings which Dell’s top insiders knew would likely
uncover numerous irregularities, including under-accruals of warranty obligations, revenue
recognition improprieties and concealment of the Intel rebate/kickback payments.
(l) Dell’s financial statements issued during the Class Period were artificially
inflated and falsified, they did not “fairly present” Dell’s results from operations and did not
comply with GAAP, as detailed in ¶¶233-273, due to a failure to properly accrue required
amounts for warranty costs, failure to recognize large product defect/recall costs and failure to
properly disclose the existence, nature and extent of the huge rebate payments Dell was receiving
each quarter from Intel.
(m) Dell’s Sarbanes-Oxley representations were false, as Dell’s internal
financial and accounting and disclosure controls were deficient and an undisclosed material fraud
was ongoing at Dell – Dell’s financial statements were being falsified, its disclosures in its SEC
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filings were false and misleading and an ongoing fraudulent violation of the securities laws was
occurring.
(n) Dell’s statements regarding its ability to quickly benefit financially from
declines in component part prices was false and misleading. The true reason for Dell’s reported
superior operating margins was, in large part, the hundreds of millions of dollars of secret and
likely illegal rebate/kickback payments Dell was receiving from Intel at the end of each quarter
in return for purchasing 100% or virtually 100% of its microprocessor requirements from Intel.
(o) Due to customer demand for PCs with the advanced features and
advantages of the new AMD microprocessor chips, Dell had decided it would have to begin to
purchase AMD chips for its computers, which would mean the loss of those hundreds of millions
of dollars of rebate/kickback payments from Intel, which would hurt Dell’s operating profits and
margins.
(p) Dell’s U.S. consumer/small business operations were not “going
gangbusters,” or achieving success, but, in fact, were performing very poorly and well below
expectations due, in large part, to the product quality and customer service and support
deficiencies outlined above.
(q) The Dell Direct business model was not advantaged in all environments
across all regions and in all product categories or able to cause Dell to report solid profits and
rapid growth regardless of prevailing market conditions due to product quality and customer
service and support due to the deficiencies and defects detailed above.
(r) The Dell Direct model did not tend to strengthen in slower growth
environments or thrive in periods of slower component price declines or show strength when
demand slowed because of the product quality and customer service and support and deficiencies
outlined above.
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(s) Dell’s purported improvements in reducing its operating expenses as a
percentage of net revenues and the reported increases in its net and gross operating profit
margins to record high levels were only being achieved at the cost of the serious product quality
and customer support and service problems outlined above and which the Dell Defendants knew
would require massive expenditures to fix, harming Dell’s profitability going forward.
(t) Due to the material adverse facts and problems set forth above, Dell and
the Dell Defendants knew that Dell could not and would not achieve the revenue, operating
profit, operating profit margins, net income and EPS growth being forecast by them.
18. The chart below graphically presents some of the defendants’ false and
misleading statements, the individual defendants’ illegal insider selling and the collapse of Dell’s
stock as the truth entered the market, i.e., matters that are the subject of this action.
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PARTIES
19. (a) Plaintiff Amalgamated Bank, as Trustee for the LongView Collective
Investment Fund (“Amalgamated Bank”) purchased the common stock of Dell at artificially
inflated prices during the Class Period as detailed in the attached certification, and was damaged
thereby.
(b) Plaintiff Wolverhampton City Council, Administering Authority for the
West Midlands Metropolitan Authorities Pension Fund purchased the common stock of Dell at
artificially inflated prices during the Class Period as detailed in the attached certification, and
was damaged thereby.
20. Defendant Dell is a public corporation with its executive offices in Round Rock,
Texas. Dell is a manufacturer and seller of computer equipment. During the Class Period, Dell
stock traded on the Nasdaq in a highly efficient market, trading millions of shares everyday.
Dell filed periodic public reports with the SEC. Dell regularly communicated with the
investment community through press releases and conference calls and had other
communications with the financial press, which followed and reported on Dell. Dell was
followed by several securities analysts who wrote reports that were widely distributed.
Defendant Dell may be served at One Dell Way, Round Rock, Texas 78682.
21. (a) Defendant Michael S. Dell (“M. Dell”) is the founder of the Company,
Chairman of the Board of Directors and was CEO of Dell throughout the Class Period until 7/04,
when Rollins became CEO. M. Dell was thoroughly knowledgeable about all aspects of Dell’s
business operations as he received constant reports regarding sales, demand, product quality and
customer service and support issues, including customer satisfaction metrics such as the “likely
to repurchase” measure. M. Dell was intimately involved in the preparation of Dell’s quarterly
and annual financial statements, including the amounts of reserves and what disclosures would
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be made, and the functioning of Dell’s internal financial and accounting and disclosure controls.
M. Dell was also intimately involved in and fully knowledgeable concerning Dell’s dealings with
Intel regarding the exclusivity “kickbacks” and the agreement between Dell and Intel not to
disclose the existence or amount of those payments. He reviewed and approved Dell’s SEC
filings and Annual Report to Shareholders and signed Dell’s F03, F04 and F05 10-Ks. During
the Class Period, M. Dell sold 85,138,000 shares of his Dell stock (26.6% of the shares he
owned) for $2,829,813,460 in insider trading proceeds. Defendant M. Dell may be served at One
Dell Way, Round Rock, Texas 78682. These sales were unusual in timing and amount and
inconsistent with M. Dell’s historical Dell stock sales, as the following chart shows.
(b) Defendant Kevin B. Rollins (“Rollins”) was President, COO and a director
of Dell throughout the Class Period until 7/04 when he became CEO of Dell. Rollins was
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thoroughly knowledgeable about all aspects of Dell’s business operations as he received constant
reports regarding sales, demand, product quality and customer service and support issues,
including customer satisfaction metrics such as the “likely to repurchase” measure. Rollins was
intimately involved in the preparation of Dell’s quarterly and annual financial statements,
including the amounts of reserves and what disclosures would be made, and the functioning of
Dell’s internal financial and accounting and disclosure controls. Rollins was also intimately
involved in and fully knowledgeable concerning Dell’s dealings with Intel regarding the
exclusivity “kickbacks” and the agreement between Dell and Intel not to disclose the existence or
amount of those payments. He reviewed and approved Dell’s SEC filings and Annual Report to
Shareholders and Dell’s F03 and F04 10-Ks and signed Dell’s F05 10-K. During the Class
Period, Rollins sold 2,163,000 shares of his Dell stock (99.3% of the shares he owned) for
$74,192,846 in insider trading proceeds. Defendant Rollins may be served at 2500 Stratford
Drive, Austin, Texas 78746. These sales were unusual in timing and amount and inconsistent
with Rollins’ historical Dell stock sales, as the following chart shows.
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(c) Defendant Joseph A. Marengi (“Marengi”) is Senior Vice President-
Americas of Dell. Marengi was thoroughly knowledgeable about all aspects of Dell’s business
operations as he received constant reports regarding sales, demand, product quality and customer
service and support issues, including customer satisfaction metrics such as the “likely to
repurchase” measure. Marengi was intimately involved in the preparation of Dell’s quarterly and
annual financial statements, including the amounts of reserves and what disclosures would be
made, and the functioning of Dell’s internal financial and accounting and disclosure controls.
Marengi was also intimately involved in and fully knowledgeable concerning Dell’s dealings
with Intel regarding the exclusivity “kickbacks” and the agreement between Dell and Intel not to
disclose the existence or amount of those payments. He reviewed and approved Dell’s SEC
filings and Annual Report to Shareholders and Dell’s F03, F04 and F05 10-Ks. During the Class
- 36 -
Period, Marengi sold 1,543,664 shares of his Dell stock (100% of the shares he owned) for
$55,197,246 in insider trading proceeds. Defendant Marengi may be served at 8211 Navidad
Drive, Austin, Texas 78735. These sales were unusual in timing and amount and inconsistent
with Marengi’s historical Dell stock sales, as the following chart shows.
(d) Defendant James M. Schneider (“Schneider”) was Senior Vice President
and CFO of Dell. On 12/19/06, Schneider was replaced at Dell as CFO. Schneider was
thoroughly knowledgeable about all aspects of Dell’s business operations as he received constant
reports regarding sales, demand, product quality and customer service and support issues,
including customer satisfaction metrics such as the “likely to repurchase” measure. Schneider
was intimately involved in the preparation of Dell’s quarterly and annual financial statements,
including the amounts of reserves and what disclosures would be made, and the functioning of
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Dell’s internal financial and accounting and disclosure controls. Schneider was also intimately
involved in and fully knowledgeable concerning Dell’s dealings with Intel regarding the
exclusivity “kickbacks” and the agreement between Dell and Intel not to disclose the existence or
amount of those payments. He reviewed and approved Dell’s SEC filings and Annual Report to
Shareholders and signed Dell’s F03, F04 and F05 10-Ks. During the Class Period, Schneider
sold 1,686,000 shares of his Dell stock (98.6% of the shares he owned) for $57,838,699 in
insider trading proceeds. Defendant Schneider may be served at 21 Hedge Lane, Austin, Texas
78746. These sales were unusual in timing and amount and inconsistent with Schneider’s
historical Dell stock sales, as the following chart shows.
(e) Defendant John K. Medica (“Medica”) is Senior Vice President-Products
of Dell. Medica was thoroughly knowledgeable about all aspects of Dell’s business operations
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as he received constant reports regarding sales, demand, product quality and customer service
and support issues, including customer satisfaction metrics such as the “likely to repurchase”
measure. Medica was intimately involved in the preparation of Dell’s quarterly and annual
financial statements, including the amounts of reserves and what disclosures would be made, and
the functioning of Dell’s internal financial and accounting and disclosure controls. Medica was
also intimately involved in and fully knowledgeable concerning Dell’s dealings with Intel
regarding the exclusivity “kickbacks” and the agreement between Dell and Intel not to disclose
the existence or amount of those payments. He reviewed and approved Dell’s SEC filings and
Annual Report to Shareholders and Dell’s F03, F04 and F05 10-Ks. During the Class Period,
Medica sold 809,956 shares of his Dell stock (98.8% of the shares he owned) for $31,315,764 in
insider trading proceeds. Defendant Medica may be served at 901 West 9th Street, Unit 904,
Austin, Texas 78701. These sales were unusual in timing and amount and inconsistent with
Medica’s historical Dell stock sales, as the following chart shows.
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(f) Defendant Rosendo G. Parra (“Parra”) is Senior Vice President-Americas
of Dell. Parra was thoroughly knowledgeable about all aspects of Dell’s business operations as
he received constant reports regarding sales, demand, product quality and customer service and
support issues, including customer satisfaction metrics such as the “likely to repurchase”
measure. Parra was intimately involved in the preparation of Dell’s quarterly and annual
financial statements, including the amounts of reserves and what disclosures would be made, and
the functioning of Dell’s internal financial and accounting and disclosure controls. Parra was
also intimately involved in and fully knowledgeable concerning Dell’s dealings with Intel
regarding the exclusivity “kickbacks” and the agreement between Dell and Intel not to disclose
the existence or amount of those payments. He reviewed and approved Dell’s SEC filings and
Annual Report to Shareholders and Dell’s F03, F04 and F05 10-Ks. During the Class Period,
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Parra sold 1,458,953 shares of his Dell stock (88.2% of the shares he owned) for $51,266,953 in
insider trading proceeds. Defendant Parra may be served at 3725 Hunterwood Point, Austin,
Texas 78746. These sales were unusual in timing and amount and inconsistent with Parra’s
historical Dell stock sales, as the following chart shows.
(g) Defendant William J. Amelio (“Amelio”) was, during the Class Period,
Senior Vice President-Asia of Dell. Amelio was thoroughly knowledgeable about all aspects of
Dell’s business operations as he received constant reports regarding sales, demand, product
quality and customer service and support issues, including customer satisfaction metrics such as
the “likely to repurchase” measure. He reviewed and approved Dell’s SEC filings and Annual
Report to Shareholders and signed Dell’s F03, F04 and F05 10-Ks. During the Class Period,
Amelio sold 1,024,281 shares of his Dell stock (93.0% of the shares he owned) for $40,067,747
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in insider trading proceeds. Defendant Amelio may be served at 208 Bella Vista, Austin, Texas
78734. These sales were unusual in timing and amount and inconsistent with Amelio’s historical
Dell stock sales, as the following chart shows.
(h) Defendant Jeffrey W. Clarke (“Clarke”) is Senior Vice President-Products
of Dell. Clarke was thoroughly knowledgeable about all aspects of Dell’s business operations as
he received constant reports regarding sales, demand, product quality and customer service and
support issues, including customer satisfaction metrics such as the “likely to repurchase”
measure. During the Class Period, Clarke sold 963,815 shares of his Dell stock (97.4% of the
shares he owned) for $35,207,325 in insider trading proceeds. Defendant Clarke may be served
at 1386 Patterson Road, Austin, Texas 78733. These sales were unusual in timing and amount
and inconsistent with Clarke’s historical Dell stock sales, as the following chart shows.
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(i) Defendant John S. Hamlin (“Hamlin”) is Senior Vice President-Global
Online Business of Dell. Hamlin was thoroughly knowledgeable about all aspects of Dell’s
business operations as he received constant reports regarding sales, demand, product quality and
customer service and support issues, including customer satisfaction metrics such as the “likely
to repurchase” measure. During the Class Period, Hamlin sold 869,443 shares of his Dell stock
(98.9% of the shares he owned) for $31,336,831 in insider trading proceeds. Defendant Hamlin
may be served at 5115 Fossil Rim Road, Austin, Texas 78746. These sales were unusual in
timing and amount and inconsistent with Hamlin’s historical Dell stock sales, as the following
chart shows.
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(j) Defendant Robert W. Davis (“Davis”) was, during the Class Period, Chief
Accounting Officer of Dell. Davis was thoroughly knowledgeable about all aspects of Dell’s
business operations as he received constant reports regarding sales, demand, product quality and
customer service and support issues, including customer satisfaction metrics such as the “likely
to repurchase” measure. Davis was intimately involved in the preparation of Dell’s quarterly and
annual financial statements, including the amounts of reserves and what disclosures would be
made, and the functioning of Dell’s internal financial and accounting and disclosure controls.
Davis was also intimately involved in and fully knowledgeable concerning Dell’s dealings with
Intel regarding the exclusivity “kickbacks” and the agreement between Dell and Intel not to
disclose the existence or amount of those payments. He reviewed and approved Dell’s SEC
filings and Annual Report to Shareholders and signed Dell’s F03 and F04 10-Ks. During the
- 44 -
Class Period, Davis sold 196,556 shares of his Dell stock (96.1% of the shares he owned) for
$7,247,401 in insider trading proceeds. Defendant Davis may be served at One Dell Way,
Round Rock, Texas 78682. These sales were unusual in timing and amount and inconsistent
with Davis’ historical Dell stock sales, as the following chart shows.
(k) Defendant Glenn E. Neland (“Neland”) is Senior Vice President-
Worldwide Procurement of Dell. Neland was intimately involved in and fully knowledgeable
concerning Dell’s dealings with Intel regarding the exclusivity “kickbacks” and the agreement
between Dell and Intel not to disclose the existence or amount of those payments. During the
Class Period, Neland sold 169,000 shares of his Dell stock (98.1% of the shares he owned) for
$6,675,330 in insider trading proceeds. Defendant Neland may be served at 1500 Barton Creek
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Blvd., Austin, Texas 78735. These sales were unusual in timing and amount and inconsistent
with Neland’s historical Dell stock sales, as the following chart shows.
(l) Defendant Randall D. Mott (“Mott”) was, during the Class Period, Senior
Vice President and CIO of Dell. Mott was intimately involved in and fully knowledgeable
concerning Dell’s internal financial and accounting and disclosure controls and the management
information system by which Dell’s top executives had instantaneous access to vital factors
impacting Dell’s sales, product quality and customer service and satisfaction. During the Class
Period, Mott sold 370,000 shares of his Dell stock (73.7% of the shares he owned) for
$14,769,800 in insider trading proceeds. Defendant Mott may be served at 3205 Winding Creek
Drive, Austin, Texas 78735. These sales were unusual in timing and amount and inconsistent
with Mott’s historical Dell stock sales, as the following chart shows.
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(m) Defendant Martin J. Garvin (“Garvin”) is Senior Vice President-
Worldwide Procurement of Dell. Garvin was intimately involved in and fully knowledgeable
concerning Dell’s dealings with Intel regarding the exclusivity “kickbacks” and the agreement
between Dell and Intel not to disclose the existence or amount of those payments. During the
Class Period, Garvin sold 90,500 shares of his Dell stock (100% of the shares he owned) for
$3,666,680 in insider trading proceeds. Defendant Garvin may be served at 8112 Navidad,
Austin, Texas 78735. These sales were unusual in timing and amount and inconsistent with
Garvin’s historical Dell stock sales, as the following chart shows.
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(n) Defendant Thomas B. Green (“Green”) was, during the Class Period,
Senior Vice President Law and Secretary of Dell. Green reviewed for accuracy and legal
compliance and helped draft Dell’s SEC filings and corporate releases during the Class Period.
Green was also intimately involved in and fully knowledgeable concerning Dell’s dealings with
Intel regarding the exclusivity “kickbacks” and the agreement between Dell and Intel not to
disclose the existence or amount of those payments. During the Class Period, Green sold
384,000 shares of his Dell stock (69.7% of the shares he owned) for $12,453,120 in insider
trading proceeds. Defendant Green may be served at 505 Lake Cliff Trail, Austin, Texas 78746.
These sales were unusual in timing and amount and inconsistent with Green’s historical Dell
stock sales, as the following chart shows.
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(o) Defendant Michael A. Miles (“Miles”) is a director of Dell. He reviewed
and approved Dell’s interim and annual financial statements issued during the Class Period and
signed Dell’s F03, F04 and F05 10-Ks. During the Class Period, Miles sold 1,428,000 shares of
his Dell stock (72.8% of the shares he owned) for $51,276,720 in insider trading proceeds.
Defendant Miles may be served at 1350 Lake Road, Lake Forest, Illinois 60045. These sales
were unusual in timing and amount and inconsistent with Miles’ historical Dell stock sales, as
the following chart shows.
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(p) Defendant Donald J. Carty (“Carty”) is a director and Audit Chairman of
Dell. As Chairman of the Audit Committee, Carty was responsible for Dell’s financial
statements, SEC filings and the system of internal accounting and financial and disclosure
controls underlying those financial statements and reports. He reviewed and approved Dell’s
interim and annual financial statements issued during the Class Period and signed Dell’s F03,
F04 and F05 10-Ks. During the Class Period, Carty sold 564,150 shares of his Dell stock (72.8%
of the shares he owned) for $20,128,490 in insider trading proceeds. Defendant Carty may be
served at 4660 Meadowood Road, Dallas, Texas 75220. These sales were unusual in timing and
amount and inconsistent with Carty’s historical Dell stock sales, as the following chart shows.
- 50 -
22. Defendant PricewaterhouseCoopers LLP (“PWC”) is a firm of certified public
accountants engaged by Dell to provide independent auditing, accounting and management
consulting services, tax services, and examination and/or review of Dell’s filings with the SEC.
PWC was engaged to perform these services so that Dell’s financial statements could be
presented to stock purchasers, government agencies, the investing public and members of the
financial community. Defendant PWC may be served at 300 Madison Avenue, 24th Floor, New
York, New York 10017.
23. PWC was also retained by the Company to review Dell’s quarterly financial
statements and to examine Dell’s internal control over financial reporting.
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24. PWC participated in the scheme to defraud by making false statements as to
Dell’s financial statements, ignoring the audit evidence that it gathered, failing to design its audit
to identify Dell’s improprieties and violating fundamental concepts of GAAS.
25. Defendant Intel Corporation (“Intel”) is a public company which primarily
manufactures and sells microprocessors or chips for computers. Intel’s two largest customers
were Hewlett-Packard and Dell. In order to improve its competitive position vis-à-vis other
manufacturers of microprocessors/chips, especially AMD, its principal domestic competitor,
Intel secretly paid very large end-of-quarter cash rebates to PC OEMs, like Dell, that purchased
all or virtually all of their microprocessor/chip requirements from Intel. These rebates, which
were, in fact, kickbacks, were not traditional volume-based discounts and the monies paid were
separate and apart from and in addition to certain publicly known, co-marketing funds which
Intel made available to certain of its customers to assist in product advertising featuring the
“Intel” name. Intel feared that if these payments became known, antitrust officials in various
countries would likely take legal action against Intel. Intel insisted that Dell not publicly
disclose the existence of these rebate/kickback payments in their communications with securities
markets or their SEC filings. Dell became very dependent upon these payments, which were
made by Intel at or near the end of the Dell’s quarter and had a direct, material impact on the
reported operating profits and profit margins of Dell. Therefore, they agreed that Dell would not
disclose the existence or amount of the payments Dell was receiving relating to the Intel
exclusive-dealing rebate/kickback scheme. Intel, of course, did not disclose the nature or
existence of its exclusive-dealing scheme in its SEC filings or other public disclosures. Intel
knew the existence and the amount of the payments Dell was receiving from it pursuant to the
exclusive-dealing rebate/kickback payment scheme was material to Dell’s reported financial
results and knew that Dell was not disclosing this information and that, as a result, Dell’s SEC
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filings, financial statements and other communications with the securities markets were false and
misleading. Defendant Intel may be served at 2200 Mission College Blvd., Santa Clara,
California 95054.
JURISDICTION AND VENUE
26. The claims asserted herein arise under and pursuant to §§10(b), 20(a) and 20A of
the Securities Exchange Act of 1934 (“1934 Act”) [15 U.S.C. §§78j(b), 78t(a) and 78t-1] and
Rule 10b-5 promulgated thereunder by the SEC [17 C.F.R. §240.10b-5].
27. This Court has jurisdiction over the subject matter of this action pursuant to 28
U.S.C. §1331 and §27 of the 1934 Act [15 U.S.C. §78aa].
28. Venue is proper in this District pursuant to §27 of the 1934 Act and 28 U.S.C.
§1391(b). Dell maintains its principal place of business in this District and many of the acts and
practices complained of herein occurred in substantial part in this District.
29. In connection with the acts in this Complaint, defendants, directly or indirectly,
used the means and instrumentalities of interstate commerce, including, but not limited to, the
mails, interstate telephone communications and the facilities of the national securities markets.
BACKGROUND TO THE CLASS PERIOD
30. Dell suffered as a result of the 2000-2001 stock market bubble bursting and the
subsequent economic downturn. Dell’s stock, which had reached an all-time high of $59.68 in
3/00, collapsed to as low as $16.25 in 12/00 and remained depressed – continuing to trade as low
as $16.01 – even in 9/01. This large decline in Dell’s stock price greatly reduced the value of the
Dell stock and stock options held by Dell’s top insiders, who sharply curtailed sales of their Dell
stock as that stock fell to low levels. Dell’s executives wanted to push Dell’s stock higher again
and knew they could do so only by persuading investors that despite the fact that Dell had now
grown into a huge company, selling millions of computers each year with annual revenues of $30
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billion by F02,2 it was still capable of achieving double-digit revenues and strong profit growth
in an increasingly competitive environment. For this to happen, it was critical that Dell reduce
its corporate expense levels and that the Dell Direct business model – “Dell Direct” –continue to
excel, providing Dell with high-quality products and superior customer support and service that
would fuel the sales growth necessary to provide strong ongoing profit growth.
31. As Dell’s stock price increased back up to $30 per share, this restored the value of
the options to purchase 387 million shares of Dell stock held by Dell’s top executives and
managers, which, by 12/02, were at an average weighted exercise price of $27.09 – making these
options – held by Dell’s top executives and managers – worth over $1.2 billion.
32. However, in late 2002 and early 2003, Dell’s stock fell again, this time from over
$30 per share to as low as $22.82 on 2/13/03. This was a loss of almost $20 billion in market
capitalization. More importantly, this almost 25% fall in Dell’s stock wiped out entirely the
value of Dell insiders’ 387 million options as Dell’s stock fell well below the $27 average
weighted exercise price, costing the Dell insiders well over one billion dollars, with the top
executives losing the most. Thus, Dell’s executives very much wanted to push Dell’s stock price
back up to much higher levels. This could only be achieved, they knew, by causing Dell to
report growing profits and profit margins, while presenting the Dell Direct business model as
continuing to achieve great success – giving Dell a competitive advantage over other computer
manufacturers, which would result in continuing growth in profits going forward.
CLASS PERIOD FALSE STATEMENTS AND DECEPTIVE CONDUCT
33. During the Class Period, beginning on 2/13/03, Dell’s top executives repeatedly
told investors that unlike every other company manufacturing and selling computer hardware
2 Dell’s fiscal year ends on 1/31 of each year. Thus, Dell’s F02 year ended on 1/31/02.
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products, Dell alone was managing to achieve very strong profitable growth, focusing investors
on its ability to achieve large amounts of operating income, high operating profit margins and
growing EPS, due to double-digit sales growth fueled by the continuing success of the Dell
Direct model, combined with sharp cuts in Dell’s overhead expenditures, eliminating billions of
dollars of annual corporate expense, but without diminishing the high quality of Dell’s products
or diminishing the high levels of customer service and support which were indispensable to the
level of customer satisfaction necessary for Dell to achieve the sales growth necessary to achieve
the financial results it was forecasting.
34. On 2/13/03, Dell reported record 4thQ F03 results for the year ended 1/31/03, via
a release stating:
Dell’s Fourth-Quarter Shipments, Revenue, Operating Income Set Company Records . . .
Dell ended its fiscal 2003 by posting best-ever quarterly . . . revenue and operating profit in the period ended Jan. 31.
* * *
Quarterly revenue was $9.7 billion, up 21 percent from last year. Company earnings were 23 cents per share, an increase of 35 percent. Full-year net earnings were $2.12 billion, on record revenue of $35.4 billion. Earnings per share for fiscal 2003 reached 80 cents, up from 65 cents . . . in the prior year.
4th Quarter Full Year (dollars in millions)
FY ‘03 FY ‘02 Change FY ‘03 FY ‘02 Change
Revenue $9,735 $8,061 21% $35,404 $31,168 14%Operating Income $819 $594 38% $2,844 $2,271 25%Net Income $603 $456 32% $2,122 $1,780 19%EPS $.23 $.17 35% $.80 $.65 23%
* * *
Kevin Rollins, Dell’s president and chief operating officer, [said] “we’re . . . consistently producing industry-leading operating results.”
- 55 -
* * *
Fourth-quarter operating income of $819 million was Dell’s highest ever. As a percent of revenue, operating income was 8.4 percent, up from the third quarter and one full point higher than a year ago. Operating expenses were 9.9 percent of revenue, matching a company low.
35. On 2/13/03, Dell held a conference call for analysts, money managers and
institutional investors to discuss its business and its 4thQ F03 results, during which the following
took place:
James M. Schneider . . . Sr. Vice President and CFO
. . . Dell outperformed the market again in the fourth quarter, improving profit margins . . . . [O]ur year-over-year revenue, units and earnings growth significantly outpaced the market. While industry revenue were down more than 2% year over year, Dell revenues increased by 21%. . . . We delivered improved profitability as operating margins increased by another 10 basis points sequentially to 8.4% . . . . [A] full point higher than last year. And our Q4 operating income of $819 million is a new company record.
* * *
Kevin B. Rollins . . . President and CEO
. . . Last year, we succeeded in reducing our cost structure by over $1.2 billion. . . . And we exceeded our initial expectations . . . . We have identified even more cost savings for fiscal year ‘04. . . . [W]e also expect to significantly reduce our warranty cost . . . [to] optimize operating income and improve operating income margins.
* * *
Michael S. Dell . . . Chairman and CEO
. . . As we enter 2003, we believe Dell is in a stronger competitive position than in any time in our history. We achieved record . . . operating income dollars . . . . Our model has advantages in every economic cycle, and . . . it is working exceptionally well . . . . Customers continue to choose Dell because they trust that we will deliver what they want at a great value. The Harris Corporate reputation poll, just released yesterday confirms this. . . . These trends will inevitably continue.
36. On 2/13/03, Bear Stearns issued a report on Dell based on the recent conference
call and follow-up conversations with Schneider and Rollins. It stated:
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• Gross Margin Expands . . . . Gross margin of 18.3%, versus 17.6% last year and last quarter’s 18.2% result, was above our forecast of 18.2%, driven by continued component cost declines and strict cost containment initiatives. . . .
• Cost Efforts Still Bearing Fruit. . . . Owing to these cost containment efforts coupled with declining component costs, Dell reported an operating margin of 8.4% – its best showing over the past 9 quarters – which was 10 basis points above the October quarter’s 8.3% and 100 basis points over the prior year. In total, Dell reduced its cost structure by $1.2 billion in FY03 . . . .
37. On 2/13/03, Thomas Weisel Partners issued a report on Dell based on the recent
conference call and follow-up conversations with Schneider and Rollins. It stated:
• Margin trends solid. The gross margin was strong at 18.3% and was 20bp above our estimate. Dell continues to manage expense effectively, with operating expenses of 9.9% . . . matching its all-time low. The end result was an operating margin of 8.4%, which was up 10bp sequentially . . . . Dell continues to focus on reducing costs, and management noted that the company exceeded its goal of $1bn in cost reduction for FY03 and that it can exceed that number for FY04.
38. On 2/14/03, Needham issued a report on Dell based on the recent conference call
and follow-up conversations with Schneider and Rollins. It stated:
• Dell reported a picture perfect quarter. . . . The company’s operating margin continued its steady upward progression to 8.4% from 7.4% a year ago.
39. On 2/14/03, Deutsche Bank issued a report on Dell based on the conference call
and follow-up conversations with Schneider and Rollins. It stated:
Dell is the best-positioned PC company based on the efficiencies of its direct model . . . .
40. On 2/25/03, M. Dell appeared at a Goldman Sachs’ conference and made a
presentation to investors, money managers, institutional investors and analysts. He stated:
[M. Dell:] . . . [W]e continue to outperform the industry . . . . [W]e improved profit margins to 8.4 percent in an environment that was reportedly more competitive than ever. . . . In terms of profitability, we held our operating expenses at 9.9 percent of revenues . . . . [W]e have been able to reduce our costs by about $1.2 billion during this past year. We have targeted even more for this
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year that we have started. And looking at our cost savings over the past two plus years, or the past two years plus the current year, we expect to realize a little over $3 billion in savings . . . . Another difference is that our cost savings is really generated from what we think are much more sustainable activities. . . . We believe our cost savings are somewhat proprietary . . . . [W]e believe Dell is in a stronger position than at any time in our history. We continue to deliver superior financial results . . . achieving record performance in . . . operating income . . . .
41. On 3/11/03, Marengi – Dell’s SVP-Americas – appeared at a Deutsche Bank
Conference for analysts, investors and money managers. He made a presentation stating:
We announced our Q4 earnings on February 13, and we outperformed the industry significantly. . . . [W]e also continued to improve our margins, and in Q4 (indiscernible) operating margins of 8.44 percent. . . . We ended with a record operating income of 819 million in the quarter, which was up 38 percent year on year. . . . Q4 capped a very, very strong year for Dell. . . . We grew operating margins by 100 basis points over the year, and we delivered a record operating income in Q4.
42. In or about 4/03, Dell issued its F03 Annual Report – for the year ended 1/31/03 –
to investors. Dell reported record F03 financial results in financial statements that were audited
and certified by PWC (in millions, except EPS):
FISCAL YEAR ENDED 1/31/03 2/1/02 CHANGE Net revenue $ 35,404 $ 31,168 13.6% Gross margin $ 6,349 $ 5,507 15.3% Operating income $ 2,844 $ 1,789 59.0% Net income $ 2,122 $ 1,246 70.3% EPS-Diluted $ 0.80 $ 0.46 73.9%
43. The F03 Annual Report also contained a letter from Rollins and M. Dell stating:
In the last fiscal year, we achieved . . . record revenue and record operating profit. . . .
Fiscal 2003 was Dell’s strongest year ever. We increased shipments, revenue and earnings per share at double-digit rates. We . . . raised profit margins at the same time.
* * *
Dell’s results were accomplished in the midst of economic softness around the world, a testament to the strength of our direct model.
* * *
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[W]e made significant progress . . . [in] product leadership . . . creating an exceptional customer experience . . . . Improvement in those areas is helping expand our competitive advantages and sustain superior operating results for the long term.
* * *
Customer Experience. We’ve always known that volume and market-share numbers are expressions of customer experience and satisfaction. We regularly assess ourselves against a broad range of customer-focused measures, including the timeliness with which we deliver built-to-order systems, the reliability with which they perform, and the speed and quality of service and support.
44. On 4/3/03, Dell held its annual investor/analyst conference in New York City for
analysts, money managers and institutional investors. During the conference the following
occurred:
[SCHNEIDER – CFO:] [W]e delivered 80 cents of EPS, $35 billion of revenues. . . . [I]n each and every one of the last eight quarters, we have met or exceeded the guidance that we have given out. It’s a very strong, consistent performance. We set records for . . . revenues, operating income, opex as a percent of revenue.
* * *
[A] lot of this came from very strong profitability. We improved our operating margins by 70 basis points. We took our operating expenses down to a record low of 9.9, . . . down below 10 percent of revenue, and generated record operating income of $2.8 billion.
* * *
And we’re still focused on a lot more cost savings. . . . [W]e’re pushing for even further cost savings. . . . [W]hen I talked about that $1 billion of cost savings in the last year, you can see the impact that had on us being able to expand our margins and our operating income.
* * *
[ROLLINS – President/COO:] Performance we believe has been exceptional in a tough environment, and I think it just speaks volumes to what we think we have with our model . . . . [We] have been able to over the last year . . . improve the operating performance of the company by over 100 basis points.
* * *
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[M. DELL – Chairman/CEO:] [W]e believe our business model is structurally advantaged . . . . This past year we achieved . . . record operating income . . . in a down year for the industry, further differentiating Dell from our competitors.
45. On 4/3/03, Deutsche Bank reported, based on Dell’s analyst/investor meeting:
• . . . Overall tone was very upbeat, with mgmt highlighting . . . [that] Dell’s business model is structurally advantaged to deliver better financial & operating performance . . . .
* * *
• We continue to believe Dell is the best-positioned PC company based on the efficiencies of its direct model . . . .
* * *
From a cost perspective, Mr. Schneider expects the company to deliver roughly $1.8 billion in cost savings in F2004, versus an approximate $1.2 billion reduction in F2003 . . . . Mr. Schneider also stressed the competitive advantage of the company’s direct model.
* * *
Michael Dell . . . believes the company’s direct model will continue to enable the company to outperform its competitors regardless of the economic climate.
46. On or about 4/28/03, Dell’s F03 Report on Form 10-K was filed with the SEC,
signed by M. Dell, Carty, Miles, Schneider and Davis. The F03 10-K contained Dell’s
previously reported F03 financial results and statements, as audited and certified by PWC. The
10-K stated:
Business Strategy
Dell’s business strategy combines its direct customer model with a highly efficient manufacturing and supply chain management organization and an emphasis on standards-based technologies. This strategy enables Dell to provide customers with . . . high-quality, relevant technology; . . . superior service and support; and products and services that are easy to buy and use. The key tenets of Dell’s business strategy are as follows:
* * *
• . . . Dell’s focus on cost control during fiscal 2003 resulted in the lowest operating expense (measured as a percent of net revenue) in Dell’s history and the lowest among its major competitors. Dell’s relentless focus on
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reducing its operating costs allows it to consistently provide customers with a superior value.
* * *
Manufacturing
Dell manufactures most of the products it sells. . . .
Dell’s manufacturing process consists of assembly, functional testing and quality control. Testing and quality control processes are also applied to components, parts and subassemblies obtained from suppliers. Quality control is maintained through the testing of components, parts and subassemblies at various stages in the manufacturing process. Quality control also includes a burn-in period for completed units after assembly, on-going product reliability audits, failure tracking for early identification of product and component problems . . . .
* * *
Fiscal 2003 Overview
Dell achieved industry-leading results and profitably grew market share in fiscal 2003 with record unit shipments, revenues and operating income dollars. . . . Dell generated record net revenue of $35.4 billion, and achieved operating income of approximately $2.8 billion, whereas its top competitors collectively continued to experience declining revenues and operating losses in their personal computer systems and related businesses. . . .
. . . In executing its strategy . . . Dell’s continued focus on cost control resulted in record low operating expenses in fiscal 2003 as a percentage of revenue as well as improved operating margins. Management believes that Dell’s continued industry-leading operating results validate that the Dell model excels in any macro-economic environment . . . .
Results of Operations
The following table summarizes the results of Dell’s operations for each of the past three fiscal years. . . .
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Fiscal Year Ended (dollars in millions)
1/31/03 Percentage
Change
2/1/02
Net revenue $35,404 14% $31,168 Gross margin $6,349 15% $5,507 % of net revenue 17.9% 17.7% Operating expenses $3,505 8% $3,236 % of net revenue 9.9% 10.4% Special charges – $482 Total operating expenses $3,505 (6%) $3,718 % of net revenue 9.9% 11.9% Operating income $2,844 59% $1,789 % of net revenue 8.0% 5.8% Net income $2,122 70% $1,246 % of net income 6.0% 4.0%
* * *
Gross Margin
Gross margin as a percentage of net revenue increased from 17.7% in fiscal 2002 to 17.9% in fiscal 2003. Gross margin increased . . . primarily as a result of Dell’s cost reduction initiatives and declining component costs. As part of its focus on improving margins, Dell remains committed to reducing costs to . . . improve profitability through . . . manufacturing costs, warranty costs . . . and overhead or operating expenses.
* * *
Operating Expenses
Fiscal Year Ended (dollars in millions)
1/31/03 2/1/02 2/2/01
Total operating expenses $3,505 $3,718 $3,780 Percentage of net income 9.9% 11.9% 11.8%
* * *
Critical Accounting Policies
Dell prepares its financial statements in conformity with generally accepted accounting principles in the U.S. Dell believes its most critical accounting policies relate to revenue recognition and warranty accruals.
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* * *
Warranty – Dell records warranty liabilities for the estimated costs that may be incurred under its basic limited warranty as well as under separately priced extended warranty and service contracts for which Dell is obligated to perform. These liabilities are accrued at the time product revenue is recognized.
47. Dell’s F03 Report on Form 10-K also contained the Sarbanes-Oxley certifications
signed by M. Dell and Schneider detailed at ¶¶269-273.
48. On 5/15/03, Dell reported record financial results for its 1stQ F04 – the quarter
ended 4/30/03 – via a release, stating:
DELL’S Q1 REVENUE UP 18 PERCENT, OPERATING INCOME UP 37 PERCENT . . .
* * *
Dell reported its best-ever fiscal first-quarter operating results . . . .
* * *
Dell’s first-quarter net earnings totaled $598 million, or 23 cents per share, up from $457 million, or 17 cents per share, for the same period one year ago. Revenue was $9.5 billion, up 18 percent from $8.1 billion.
1st Quarter FY ‘04 FY ‘03 Change Revenue $9,532 $8,066 18% Operating Income $811 $590 37% Net Income $598 $457 31% EPS $.23 $.17 35%
“Dell’s unique ability is innovating, integrating and delivering technology with the best possible value, and our execution in those areas has never been better,” . . . [said Michael S. Dell].
First-quarter operating profit as a percent of revenue was 8.5 percent, Dell’s highest in two and one-half years. Operating expenses were a record low 9.8 percent of revenue, down from 9.9 percent a year ago.
49. On 5/15/03, Dell held a conference call for analysts, money managers and
institutional investors to discuss Dell’s business and 1stQ F04 results. During the call, the
following occurred:
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[SCHNEIDER – CFO] . . . Dell has consistently outperformed the market in all competitive environments and continues to do so . . . . Specifically, our year-over-year revenue, unit and earnings growth significantly outpaced the market. While we believe industry revenues were down 5% year-over-year, sales revenue grew by 18% . . . . We delivered improved profitability as operating income dollars grew by more than 37 percent year over year.
. . . [W]e delivered 23 cents in earnings per share on $9.5 billion in revenues . . . . [E]arnings grew significantly with earnings per share [up] 35 percent year over year. . . .
* * *
[M. DELL – Chairman/CEO] . . . [O]ur model is structurally advantaged enabling us to consistently deliver exceptional financial and operating performance in all environments.
50. On 5/28/03, Bear Stearns issued a report on Dell, based on meetings with top Dell
executives, reporting to the market what the executives had said to Bear Stearns:
Dell Computer Corp. – Outperform
* * *
A Visit To Dell: Takeaways From Meetings With Dell Management
* * *
Meeting with Kevin Rollins, President & COO
* * *
• Consumer “Going Gangbusters”: COO Kevin Rollins was very upbeat about Dell’s performance and outlook in its consumer efforts saying that the consumer business is profitable, growing, and its brand is strengthening.
* * *
Meeting With Marty Garvin, Senior VP (Worldwide Procurement):
• Component Basket Still Trending Down: . . . Overall, Dell noted that the rate of component declines is slightly less than the prior quarter but the overall basket is still trending down.
• Lower Cost Doesn’t Mean Lower Quality: Speaking about the tradeoffs between cost and quality of components, Dell noted that Dell’s focus on driving down cost does not mean that there are quality tradeoffs . . . .
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51. On 6/16/03, Dell filed its 1stQ F04 10-Q Report with the SEC. It was signed by
Davis. The 10-Q reported the same financial results earlier reported. It also stated:
First Quarter Overview
During the first quarter of fiscal 2004, Dell’s performance once again significantly exceeded the industry . . . .
. . . During the first quarter of fiscal 2004, Dell leveraged its low-cost structure and efficient direct-to-customer model to aggressively price and pass through declining component prices and structural savings . . . . Gross margins increased from the first quarter of fiscal year 2003 as a result of Dell’s cost reduction initiatives and component cost declines. Dell’s continued focus on cost control also resulted in record-low operating expenses during the first quarter as a percentage of net revenue. . . . [T]he Dell model excels in any macro-economic environment . . . .
Gross Margin
Gross margin as a percentage of net revenue increased from 17.2% in the first quarter of fiscal 2003 to 18.3% in the first quarter of fiscal 2004 . . . . The year-over-year improvement in gross margin occurred primarily as a result of Dell’s cost savings initiatives and declining component costs. As part of its focus on improving margins, Dell remains committed to reducing costs to maintain price leadership and improve profitability through four primary cost reduction initiatives: manufacturing costs, warranty costs . . . and overhead or operating expenses.
. . . [T]he strength of Dell’s direct-to-customer business model . . . makes Dell better positioned than its competitors to profitably grow market share in any business climate.
Operating Expenses
The following table presents certain information regarding Dell’s operating expenses during the periods indicated:
Three Months Ended (dollars in millions)
5/2/03 5/3/02 Dollars
% of Net Revenue
Dollars % of Net Revenue
Total operating expenses $937 9.8% $801 9.9%
Total operating expenses decreased as a percentage of revenue in the first quarter of fiscal 2004 as compared to the first quarter of fiscal 2003,
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primarily as a result of the previously referred to cost savings initiatives, including providing certain customer technical support . . . functions from low-cost sites . . . .
52. Dell’s 1stQ F04 10-Q also contained the Sarbanes-Oxley certifications signed by
Schneider and M. Dell, detailed at ¶¶269-273.
53. On 8/14/03, Dell reported record financial results for the 2ndQ F04 via a release,
stating:
Dell’s Superior Execution Produces Record Shipments, Revenue and Operating Income . . .
Continued strong growth . . . helped Dell achieve best-ever quarterly results in the period ended Aug. 1 . . . .
* * *
Second-quarter revenue was $9.8 billion, up 16 percent from the same period one year ago. Per-share earnings were 24 cents, an increase of 26 percent.
2nd Quarter Year to Date
FY ‘04 FY ‘03 Change FY ‘04 FY ‘03 Change (in millions)
Revenue $9,778 $8,459 16% $19,310 $16,525 17%Operating Income $840 $677 24% $1,651 $1,267 30%Net Income $621 $501 24% $1,219 $958 27%EPS $.24 $.19 26% $.47 $.36 31%
* * *
Second quarter operating expenses were a record-low 9.6 percent of revenue, down from 9.8 in the first quarter and 9.9 percent a year ago. Operating profit as a percent of revenue increased to 8.6 percent – the company’s highest in nearly three years and up from 8.0 percent in last year’s second quarter.
* * *
Respondents to a recent survey by a leading Japanese information-technology publication ranked Dell No. 1 in customer satisfaction for standards-based servers for the fifth consecutive year.
* * *
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Product Leadership Earns Continued Recognition
* * *
Third-party opinions underscored Dell’s strength with customers in enterprise product categories. Technology Business Research (TBR) ranked Dell No. 1 in service and support for standards-based servers for eight consecutive quarters.
54. On 8/14/03, Dell held a conference call with analysts, money managers and
institutional investors to discuss its business and its 2ndQ F04 results. During the call, the
following occurred:
[Schneider – SVP, CFO:] Dell has consistently outperformed the market in all competitive environments and continued to do so in the second quarter. Specifically, our year-over-year revenue, unit, and earnings growth continue to outpace the market. While we estimate that industry revenues were flat year-over-year, Dell revenues grew by 16%. . . . And we delivered improved profitability as operating income dollars continue to grow faster than revenues. We delivered 24 cents in earnings per share, up 26% year-over-year, a $9.8 billion in revenues. . . . [W]e achieved an expense ratio of 9.6%, the lowest in company history. Operating income margins increased 10 basis points sequentially and 60 basis points year-over-year to 8.6%, despite challenging market conditions. . . . [O]ur products were recognized by industry experts for their quality and performance.
* * *
[Rollins – President, COO:] First, the nature, magnitude and sustainability of Dell’s cost advantage. Second, the consistently high quality earnings and industry leading returns generated by our business model and focus strategy. . . . Starting with our cost advantage. Traditionally, our cost advantage has been driven by our ability to rapidly pass along component cost declines to customers and maintain lean inventory levels . . . [and by] manufacturing efficiency, and a very lean operating cost structure. These cost advantages are structural, inherent to our model, and accrue uniquely to Dell. . . . Though our advantage is significant across all product categories and in all market environments, and we will continue to widen the gap with our competitors, we have removed over $3 billion from our cost structure over the past two years and are on track to remove about $1.5 billion in cost this year and have identified additional cost savings to take us well into the future. The second topic is the consistently high quality of earnings and industry leading returns generated by Dell’s business model and focused strategy.
* * *
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[M. Dell – Chairman, CEO:] [W]e continue to demonstrate a focus model that is structurally advantaged and drive[s] leading financial operating performance and . . . yields leading shareholder value creation. . . . And all of this gives us great confidence that we remain on track to achieve our goal of $60 billion in revenue.
55. On 8/15/03, JP Morgan issued a report on Dell, based on the recent conference
call, which stated:
• Dell delivered in line earnings and revenues of $0.24 and $9.78 billion.
* * *
The company is resoundingly confident about its market strategy in PCs and servers, and Dell also continues to trumpet its sterling cost structure advantage.
56. On 8/18/03, Neeham issued a report on Dell, based on the recent conference call,
which stated:
• . . . Dell reported another picture perfect quarter. . . .
• Dell’s . . . operating margin ticked up from 8.5% to 8.6% thanks to continued exceptional expense controls. . . . [O]perating income rose 22.1%, demonstrating the efficiency of the Dell model.
57. On 9/2/03, Dell issued a release representing the high quality of its products and
the high customer satisfaction Dell was enjoying, due to the Dell Direct model:
A commitment to high customer satisfaction and providing customers with the greatest value has enabled Dell to extend its lead as the world’s No. 1 provider of personal computer systems . . . .
* * *
“We continue to provide our customers with the highest quality products . . . ,” Kevin Rollins, Dell president and chief operating officer, said . . . .
58. On 10/8/03, Dell held a conference call with analysts, money managers and
institutional investors to discuss its business. On 10/9/03, UBS issued a report on Dell based on
the recent conference call, which stated:
Yesterday, Dell hosted its Strategy Update conference call w/COO Kevin Rollins . . . . Dell also reaffirmed that it can expand its operating margins to
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10% (from 8.5% currently) and was even ahead of plan . . . . Dell believes that there are four areas for cost reductions . . . [including] lower warranty costs . . . improving call center efficiency, and lowering fixed costs and . . . structural cost improvements . . . .
59. The positive statements made by defendants regarding Dell during 2/03-10/03,
detailed above, inflated Dell’s stock to a high of $37.18 on 10/21/03 from $22.82 on 2/13/03 – an
increase of 63%, or $36 billion in market capitalization. As Dell’s stock soared to these
artificially inflated levels, it restored the value of Dell’s top executives’ stock options as they
went “in the money.” Dell insiders then began to unload their stock to profit from their “pump-
and-dump” scheme. Between 2/28/03 and 9/22/03, they sold off nearly 39 million shares of their
Dell stock for $1.16 billion in illegal insider trading proceeds.
60. The statements made between 2/03-10/03 included:
• Dell was reporting “record” and “industry-leading” financial results, including “high-quality” earnings and operating income, and operating profit margins, while achieving lower operating expenses as a percentage of revenue.
• Dell’s “record” financial results and “exceptional financial performance” were a “testament to the strengths of [Dell’s] direct model” and “speak[] volumes [as to Dell’s] model” which “consistently deliver[s] exceptional financial and operating performance” in “any macro-economic environment” and “in any business climate.”
• Dell’s “business model [was] structurally advantaged,” resulting in customers trusting Dell due to their “exceptional customer experience,” making Dell “No. 1 in customer satisfaction” and “service and support” due to Dell’s “highest quality products,” which were “recognized . . . for quality and performance” – “helping expand [Dell’s] competitive advantages,” which would “sustain superior operating results for the long term.”
• Dell’s outstanding financial results were due to “record low” operating expenses “due to Dell’s cost savings initiatives,” including reduced “manufacturing costs” and “declining component costs,” as well as “providing customer support functions from low cost sites.” Dell had eliminated $1.2 billion in annual costs, and was targeting “$3 billion more in cost reductions,” which cost savings were from “sustainable activities.” But “lower cost doesn’t mean there are quality trade-offs,” meaning Dell was producing “high quality products” that were “easy to buy,” together with “superior service and support.”
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• Dell’s top officers had reviewed Dell’s internal financial and accounting and disclosure controls; those controls were effective to assure accurate preparation of Dell’s SEC filings and that no undisclosed deficiencies in Dell’s internal controls or fraud – material or otherwise – existed at Dell.
These statements impacted and were reflected in the market trading price of Dell’s stock and
other publicly traded securities. The statements set forth in ¶¶34-60 were false and misleading
when made. The true facts, which were known to or recklessly disregarded by each of the Dell
Defendants, but not disclosed by them, were:
(a) The Dell Direct business model was not operating successfully or creating
the strong, often record, financial results and operating margins Dell was reporting; in fact, due
to overly aggressive cost-cutting in Dell’s customer support and service and manufacturing
operations, Dell’s business model was being afflicted with sky-rocketing customer
dissatisfaction and complaints, as well as increasing product quality problems (especially with
laptop batteries and capacitors). In truth, Dell’s financial results were being falsified and
temporarily inflated by (i) large cost-cuts which would have to be reversed and remediated; (ii)
improper accounting tricks, including under-accruing warranty costs and failing to take timely
write-downs for defective products and product replacement; and (iii) its secret receipt of some
$200 million per quarter in rebate/kickback payments from Intel in return for exclusively
purchasing Intel microprocessors/chips.
(b) Dell was not manufacturing or selling the highest quality products, as
Dell’s aggressive cost-cutting in its manufacturing operations to boost its reported profits in the
short term had badly weakened Dell’s quality control procedures and standards for component
parts, i.e., batteries and finished goods, such that Dell was encountering an upsurge in customer
complaints due to faulty products, including capacitor failures, motherboard failures and
widespread laptop (lithium) battery defects.
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(c) Dell did not have an unrivaled ability to create products or technologies
that met or exceeded customer expectations, nor did it have world-class manufacturing
excellence, producing high-quality products. In fact, as a result of the aggressive cost cuts in
Dell’s manufacturing operations, Dell’s quality assurance procedures had become badly
impaired, leading to a marked decline in product quality.
(d) Dell’s cost-cutting program was resulting in a marked increase in the
production of defective products which did not meet Dell’s historic quality standards and a
marked decline in Dell’s historic levels of customer support and service and thus customer
satisfaction, which Dell insiders knew would cost hundreds of millions, if not billions, of dollars
to remedy, including the hiring of thousands of additional full-time employees to be trained to
staff customer call centers and to improve Dell’s quality assurance techniques and practices in its
manufacturing operations.
(e) In order to cut operating costs, Dell had sharply curtailed its quality
control processes by no longer testing component parts (specifically batteries, hard drives,
optical drives or motherboards and laptop accessory parts, including power adaptors) received
from suppliers. Rather, Dell was relying on post-assembly quick tests of completed units to
discover defective component parts. In addition, it had also curtailed the post-assembly “burn-
in” testing of units, which steps in combination were resulting in Dell shipping much larger
numbers of computers with defects and performance problems, leading to increased quality
problems and customer dissatisfaction.
(f) Dell was not providing superior customer service and support as, due to
overly aggressive cost-cutting activities in Dell’s customer support and service operations to
boost its reported profits in the short term, including moving most of Dell’s consumer and small
business customer support and service call centers to India and the Philippines and replacing full-
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time, well-trained employees with part-time, ill-trained (but cheaper) employees, Dell’s customer
support and service operations were badly impaired, resulting in very long wait times and an
inability to adequately respond to customer complaints and questions, generating an upsurge in
customer anger and dissatisfaction with Dell, its products and its customer support and service,
which Dell’s internal metrics showed would hurt sales.
(g) Because of its shifting of much of its customer support and service
operations, especially for its consumer and small business customers, to “call centers” in India
and the Philippines and staffing its call centers with part-time, poorly trained employees, Dell
was no longer providing a superior customer experience or generating high degrees of (or
improving) customer satisfaction. Rather, Dell was encountering a widespread customer revolt
with a massive upsurge in complaints regarding declining product quality and declining service
and support operations and a sharp decline in one of Dell’s key internal metrics – the “likely to
repurchase” number.
(h) The Dell Direct model also was not functioning effectively with respect to
Dell’s direct sales process because Dell had flooded the market with a huge number of confusing
and contradictory promotional offers which its now ill-trained and inadequate sales force was
unable to effectively process. This was leading to refusals to honor many “coupons” and
“promotions,” resulting in customer dissatisfaction and refusal to buy Dell products, which was
showing up in an important internal Dell metric known as the “likely to repurchase” number,
where Dell was seeing soaring negative sentiment which meant customers were displeased with
the Dell sales process and thus Dell’s sales growth would decline.
(i) While Dell publicly disseminated favorable surveys and reports purporting
to show high degrees of Dell customer satisfaction with product quality and service and support,
in fact, its own internal surveys, information and customer metrics (which it constantly
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monitored) showed a huge upsurge in customer dissatisfaction with and anger at Dell, including
a measurable increase in negative responses to its most important metric, the so-called “likely to
repurchase” number, which Dell knew indicated serious problems with ongoing sales growth.
(j) Dell had quietly curtailed the length of its product warranty and sharply
curtailed the breadth of its warranty coverage (it had eliminated the computer operating system
from its warranty) and, in addition, had secretly adopted a new “fix-on-fail-only” policy whereby
it would provide in-home repair service or product replacement only when a computer (or
component) completely failed, as opposed to merely malfunctioned, to cut costs. However, these
severe restrictions in Dell’s warranty and service to its customers – which were much different
than Dell’s historic “customer friendly” approach to warranty, service and product quality issues
– were causing an upsurge in customer dissatisfaction with and anger at Dell, which Dell insiders
knew would inevitably result in declining sales growth and a massive increase in warranty and
product repair costs to try to restore customers’ satisfaction to acceptable levels.
(k) Dell’s 4thQ F03 and 1stQ and 2ndQ F04 financial results and statements
were artificially inflated and falsified, as detailed in ¶¶233-273, due to a failure to properly
accrue required amounts for warranty costs, failure to recognize material product defect/recall
costs and failure to properly disclose the existence, nature and extent of the huge rebate
payments Dell was receiving each quarter from Intel.
(l) Dell’s statements regarding its ability to quickly benefit financially from
declines in component part prices was false and misleading. The true reason for Dell’s reported
superior operating margins was, in large part, the hundreds of millions of dollars of secret and
likely illegal rebate/kickback payments Dell was receiving from Intel at the end of each quarter
in return for purchasing 100% or virtually 100% of its microprocessor requirements from Intel.
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(m) The Dell Direct business model was not advantaged in all environments or
business or economic conditions or able to cause Dell to report solid profits and rapid growth
regardless of prevailing market conditions due to product quality and customer service and
support due to the deficiencies and defects detailed above.
(n) Dell’s purported improvements in reducing its operating expenses as a
percentage of net revenues and the reported increases in its net and gross operating profit
margins to record high levels were only being achieved at the cost of the serious product quality
and customer support and service problems outlined above and which the Dell Defendants knew
would require massive expenditures to fix, harming Dell’s profitability going forward.
61. On 11/13/03, Dell issued a release reporting record 3rdQ F04 results:
Strong Growth . . . Leads Dell to Record Operating Results in Fiscal Third Quarter; Company Anticipates $11.5 Billion in Revenue, EPS of 28 Cents in Q4
Dell again demonstrated its unique ability to simultaneously deliver . . . leading profitability, achieving record company operating results in the fiscal third quarter.
* * *
For the three months ended Oct. 31, Dell’s net revenue was $10.6 billion, 16 percent higher than in the year-ago quarter. . . . sales by the rest of the industry are essentially flat over the same period. Third-quarter Dell earnings were 26 cents per share, a 24-percent increase.
3rd Quarter Year to Date
FY ‘04 FY ‘03 Change FY ‘04 FY ‘03 Change
Revenue $10,622 $9,144 16% $29,932 $25,669 17% Operating Income $912 $758 20% $2,563 $2,025 27% Net Income $677 $561 21% $1,896 $1,519 25% EPS $.26 $.21 24% $.72 $.57 26%
* * *
Third-quarter operating expenses were 9.6 percent of revenue, equaling a company record. . . . Dell’s operating profit was 8.6 percent of revenue for the
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second straight quarter. In dollar terms, operating income was $912 million, up 20 percent from a year ago.
62. On 11/13/03, Dell held a conference call with analysts, money managers and
institutional investors to discuss its 3rdQ F04 results and its business. During the call, the
following occurred:
[Schneider – CFO] Dell’s direct model and realtime information flow enable us to move quickly and precisely in order to deliver outstanding results in any environment; and we did this again in the third quarter. Specifically, our year-over-year revenue, unit, and profit growth continued to outpace the market. While industry units were up in the mid-teens we estimate that industry revenues were up only in the single digits year-over-year. Meanwhile Dell revenues grew by 16% to $10.6 billion, a new company record. Dell also delivered record operating profit and record earnings for the quarter. . . .
. . . Dell’s quality . . . of earnings continues to lead the market as we turned in yet another quarter of strong revenue and earnings growth.
In the third quarter, we delivered 26 cents in earnings per share, an increase of 24% year-over-year . . . .
* * *
[Rollins – COO] . . . Dell’s operating model provides us with information flow advantages that are incremental to our structural cost advantages. Combined, these advantages enable Dell to continue to post solid profits and rapid growth, regardless of the prevailing market conditions. Going forward, continued share gains along with solid progress in attractive growth areas will enable us to achieve and profitably grow beyond our stated target of $60 billion in annual revenues.
* * *
[M. Dell – CEO] . . . [Y]ou can see from our results that our model is structurally advantaged and it’s enabling us to consistently deliver exceptional financial and operating performance in all environments. . . . The Dell model is winning, our growth strategy is progressing as planned . . . and [w]e’re very well positioned for the future.
63. On 11/24/03, The Wall Street Journal reported that Dell had stopped sending
corporate customer service/support calls to its call centers in India:
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Dell Inc.: Corporate Support Calls Won’t Go to Center in India
Dell Inc., stopped sending U.S. corporate-technical-support calls to its Bangalore, India, call center after commercial customers complained. The Austin, Texas, computer maker said support for U.S. purchasers of its Optiplex desktop and Latitude notebook computers will be handled solely by facilities in Texas, Idaho and Tennessee.
Other products and regions won’t be affected. . . . More of Dell’s home-computer and consumer-electronics calls will be routed to Bangalore, a spokesman said. The moves won’t affect employment in India or the U.S., he said. “It’s a redistribution of tasks and calling queues,” he said. “Corporate customers were telling us they didn’t like the level of tech support they were getting.” He couldn’t provide specifics. Brooks Gray, a senior analyst at Technology Business Research Inc., said Dell customers cited language problems and delays in reaching senior technicians.
64. On 12/5/03, Ethnic NewsWatch India Abroad reported that Dell had assured
investors that it was not closing or reducing its work force at the Indian call centers and that this
was “a routine thing and not a big deal”:
Dell says India workforce won’t be reduced
* * *
Dell . . . has denied media reports that it is reducing the workforce at its Bangalore center because of customer complaints.
“The company has no plans to close down some of the call centers or reduce workforce in India. Our customers are satisfied with the service they are getting from call centers in India,” Barry French, a spokesperson for the Texas-based Dell, said.
French did not deny a few technical support jobs would be moved back to the U.S. but pointed out that they were changes in the company’s process and “routine.”
“Periodically, the company makes changes in areas such as customer care. Some of the work being done in one office may be shifted to another office in another country. This is a routine thing and not a big deal,” he said.
65. On 12/15/03, Dell filed its 3rdQ F04 Report on Form 10-Q with the SEC. It was
signed by Davis. It contained the same financial results earlier reported. It also stated:
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Third Quarter Overview
. . . During the third quarter of fiscal 2004, Dell’s year-over-year performance continued to outpace the industry. . . . Net revenue increased 16% year-over-year to $10.6 billion during the quarter with operating expenses remaining at a record low 9.6% of net revenue. During the third quarter, Dell continued its focus on maximizing operating dollars by achieving record operating profits and net income of $912 million and $677 million, respectively. . . . Dell’s low-cost structure and efficient direct-to-customer model have enabled the company to consistently achieve year-over-year market share growth while maximizing operating profitability.
* * *
Gross Margin
Gross margin as a percentage of net revenue remained at 18.2% during the third quarter of fiscal 2004 . . . . Gross margin was 18.2% for the nine months ended October 31, 2003 and 17.8% during the same period last year. The year-over-year improvement for the nine months ended October 31, 2003 was primarily driven by Dell’s cost savings initiatives. As part of management’s focus on improving margins, Dell remains committed to reducing . . . manufacturing costs, warranty costs . . . and overhead or operating expenses. These cost savings initiatives also include providing certain customer technical support . . . from cost effective locations . . . .
* * *
Operating expenses
The following table presents certain information regarding Dell’s operating expenses during the periods indicated:
Three Months Ended Nine Months Ended (dollars in millions)
10/31/03 11/1/02 10/31/03 11/1/02
Dollars % of Net Revenue
\ Dollars
% of Net Revenue
Dollars
% of Net Revenue
Dollars
% of Net Revenue
Selling, general and administrative
$905 8.5% $787 8.6% $2,553 8.5% $2,205 8.6%
Research, development and engineering
$118 1.1% $117 1.3% $345 1.2% $338 1.3%
TOTAL operating expenses
$1,023 9.6% $904 9.9% $2,898 9.7% $2,543 9.9%
During the third quarter, Dell maintained its record low operating expenses as a percentage of net revenue of 9.6%, compared to 9.9% in the same quarter last year. The decrease was primarily a result of previously referred to cost reduction initiatives.
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66. Dell’s 3rdQ F04 10-Q also contained the Sarbanes-Oxley certifications, signed by
Schneider and M. Dell, detailed at ¶¶269-273.
67. On 2/12/04, Dell issued a release reporting record 4thQ F04 and F04 results:
Dell Posts Record Operating Results in Fiscal Fourth Quarter . . . 18-Percent Revenue Growth, 26-Percent Increase in EPS . . .
Dell’s fiscal fourth-quarter 2004 was its best operating period ever. The company achieved record product shipments, revenue, operating and net income, and earnings per share.
* * *
Company revenue for the quarter ended Jan. 30 was $11.5 billion, 18 percent higher than a year ago. Net earnings were 29 cents per share, up 26 percent. Full-year sales were $41.4 billion, operating income was $3.5 billion and per-share earnings were $1.01, all Dell records.
4th Quarter Full Year
FY ‘04 FY ‘03 Change FY ‘04 FY ‘03 Change (in millions, except per share data)
Revenue $11,512 $9,735 18% $41,444 $35,404 17% Operating Income $981 $819 20% $3,544 $2,844 25% Net Income $749 $603 24% $2,645 $2,122 25% EPS $.2 $.23 26% $1.01 $.80 26%
“Dell is alone in simultaneously providing customers great value, growing faster than the industry and earning a compelling profit for investors,” said Kevin Rollins, the company’s president and chief operating officer. “Doing that requires a high-quality, low-cost business model. We have both.”
* * *
Dell’s profitability was up strongly from a year ago, both in absolute terms and as a percent of revenue. Fourth-quarter operating income was $981 million, or 8.5 percent of revenue. Operating expenses were 9.6 percent of revenue, matching a company low and down from 9.9 percent in the year-ago quarter.
68. On 2/12/04, Dell held a conference call for analysts, money managers and
institutional investors to discuss Dell’s business and its F04 results. During the call the
following occurred:
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[Schneider – CFO and SVP:] Our fourth quarter results cap a year of impressive performance in a market where competitors continued to operate without profits. . . .
In the fourth quarter we hit our targets again. Marking the twelfth consecutive quarter in which we have met or exceeded our guidance to investors. And we generated record . . . revenues, operating income and earnings per share. Looking at our full-year results, we exceeded our plans for the fiscal year ‘04. . . . With . . . operating income up 25% to $3.5 billion for the full year. All new records. We . . . are well on our way to meeting our goal of $60 billion in annual revenues.
. . . Our model consistently delivers growth that is accretive to shareholder value.
* * *
Fiscal ‘04 was an excellent year for Dell. And our financial and operating performance validates that we have the right focus and strategy. As a result, we enter the new year in a stronger competitive position than ever.
. . . Dell’s quality and consistency of earnings continued to lead the market. . . . We delivered 29 cents in earnings per share. An increase of 26% year over year . . . .
* * *
[Rollins – President and COO:] . . . I’d like to . . . discuss . . . the success of Dell’s industry leading business model . . . .
* * *
We owner-operate our factories. Driving efficiencies through global scale and proprietary practices that can only be realized by owning manufacturing operations. . . . We have grown our operating profits by more than 50% over the last two years . . . . In fiscal year ‘04, Dell turned in another strong performance in our core business . . . . Clearly demonstrating that Dell’s business model is advantaged in all environments across all regions and in all product categories.
69. On 3/17/04, The Financial Times published an article concerning Dell’s continued
use of Intel as its sole source of its supply of microprocessors:
Dell puts its faith in the Intel it knows: MICROPROCESSORS: AMD’s powerful new chip may not tempt away PC makers . . .
Michael Dell has built the world’s second biggest computer manufacturer on simplicity. Dell sells direct to customers, bypassing the resellers that once dominated the hardware industry. He will not give up that simplicity easily, he says.
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While rivals offer computers based on different microprocessors, Mr. Dell sticks firmly to Intel. Hewlett-Packard, in contrast, offers on its website computers similar in virtually every detail except their microprocessor. Customers can choose machines with Intel processors or similar models with chips from Advanced Micro Devices.
70. On 4/8/04, Dell held its annual Analyst Day in Austin, Texas for investors,
stockholders, analysts and money managers. During the presentation, the following occurred:
[Schneider:] . . . [O]ur model, our advantage business model and our focused strategy and consistent executions allows us to continue to drive superior results. And . . . our strong focus on cutting costs and continuing to drive our profitable growth . . . [of] 26% EPS growth. . . . [W]e were. . . able to improve our operating margins. . . . [O]ur focus on operating expenses, took that down to a record low 9.7% of revenue which drove operating income dollars to new records, $3.5 billion. . . . This cost-saving element is something that we just can’t focus on enough. . . . We first gave out targets a couple years ago, since that time we generated about $4 billion of cost savings. . . . You can look at our manufacturing cost side of it, the throughput through our factories. And the last three years, I mentioned that we’ve had over 20% unit growth annually. Yet, in these last three years, we’ve actually reduced the number of manufacturing facilities that we have. Also, actually reduced the number of people that are involved in the manufacturing process. . . . So, it’s put us in a position to take our manufacturing costs down significantly. . . . Another category is warranty. . . . Very focused on improving [product] quality, which, over time, also reduces our warranty costs, our experience is much better. Our warranty costs on notebooks and desktops over the last three years have declined about 50%. [It’s not] just the product quality, it’s the wholesale service and support that . . . [w]e handle in the most efficient and effective way possible.
71. On 4/8/04, Deutsche Bank issued a report on Dell’s Analyst Day:
• Throughout the presentations, management highlighted the company’s structurally advantaged business model and showed how it compared favorably with its peers from a profit, growth, and industry positioning perspective.
* * *
Kevin Rollins, President and COO
Mr. Rollins reviewed the advantage of Dell’s business model, citing Dell’s efficiency and control in its manufacturing process (compared to competitors’ outsourcing) . . . .
* * *
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Michael Dell, Chairman and CEO
Mr. Dell highlighted the company from a growth perspective, indicating that Dell was ahead of its plan to reach $60B in revenue.
72. On 4/8/04, Prudential Equity issued a report on Dell’s Analyst Day:
DELL: COMPANY TRACKING AHEAD OF $60B REVENUE GOAL – RAISING FY05 AND FY06 ESTIMATES
* * *
• Most of the presentations were top level in nature, with mgmt touting the benefits of the direct model . . . .
• Most significant were mgmt’s comments that the company is tracking ahead of its goal for $60B in revenue in FY07.
73. In or about 4/04, Dell issued its F04 Annual Report. It contained the following
financial results in financial statements audited and certified by PWC:
OPERATING RESULTS (in millions, per-share data)
Fiscal Year Ended 1/30/04 1/31/03 Change Net revenue $41,444 $35,404 17.1% Gross margin $7,552 $6,349 18.9% Operating income $3,544 $2,844 24.6% Net income $2,645 $2,122 24.6% Income per common share Diluted $1.01 $.80 26.3%
74. The F04 Dell Annual Report to Shareholders also contained a letter from M. Dell
and Rollins:
To our Customers, Shareholders, Partners and Employees:
Customers made Dell’s fiscal 2004 the most successful of the 20 years since our founding. . . .
Dell’s full-year . . . revenue, operating profit and earnings per share were all company records. . . .
. . . Our revenue increased 17 percent, to $41.4 billion; total sales by the rest of the industry declined. Operating expenses accounted for just 9.7 percent of revenue, the lowest full-year rate in our history, and were 9.6 percent for the last three quarters. Earnings per share were up 26 percent, to $1.01; competitors lost money in their computer-systems businesses.
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In April 2002, in the midst of our industry’s most trying period ever, we declared an ambitious objective to double Dell sales to more than $60 billion in about five years. Some observers believed the goal unattainable. However, two years later we are ahead of the pace toward the target.
* * *
We again demonstrated the fundamental advantages of our high-quality, low-cost business model . . . .
* * *
Our ability to understand and act on customer requirements is unmistakable: Dell earned more than 100 awards for product and service quality and reliability last year alone. . . . Technology Business Research ranked Dell No. 1 for overall service and support among hardware vendors, and first in customer satisfaction . . . .
* * *
We regularly measure our performance from the customer’s perspective. As examples, we track how easy it is to contact Dell, the accuracy with which orders are fulfilled, if deliveries are on time, overall product quality, whether we correct an issue the first time, and if our customers are treated with courtesy and respect. Our vision is not just to provide the best customer experience in our industry, but to be counted among the best in any business.
75. On 4/12/04, Dell’s F04 10-K was filed with the SEC, signed by Schneider, Miles,
Carty, Davis and M. Dell. It reported Dell’s F04 financial results in financial statements audited
and certified by PWC. The 10-K stated:
Manufacturing
Dell manufactures most of the product its sells. Dell has six manufacturing locations worldwide to service its global customer base. Dell believes that its manufacturing processes . . . provide it a distinct competitive advantage. . . . Dell’s supply chain management decreases Dell’s exposure to the risk of declining inventory values . . . .
Dell’s manufacturing process consists of assembly, functional testing, and quality control. Testing and quality control processes are also applied to components, parts, and subassemblies obtained from suppliers. Quality control is maintained through the testing of components, parts, and subassemblies at various stages in the manufacturing process. Quality control also includes a burn-in period for completed units after assembly, on-going product reliability audits, failure tracking for early identification of production and component
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problems, and information from Dell’s customers obtained through services and support programs.
* * *
Dell’s business strategy combines its direct customer model with a highly efficient manufacturing . . . organization . . . . This strategy enables Dell to provide customers with . . . high-quality, relevant technology; . . . superior service and support; and products and services that are easy to buy and use. . . . [T]he Dell model provides the company with advantages in all environments . . . .
The following table summarizes Dell’s consolidated results of operations for each of the past three fiscal years:
Fiscal Year Ended (dollars in millions)
1/30/04 %
Change
1/31/03 %
Change
2/1/02
Net revenue $41,444 17% $35,404 14% $31,168Gross margin $7,552 19% $6,349 15% $5,507 % of net revenue 18.2% 17.9% 17.7%Operating expenses $4,008 14% $3,505 (6%) $3,718 % of net revenue 9.7% 9.9% 11.9%Operating income $3,544 25% $2,844 59% $1,789 % of net revenue 8.6% 8.0% 5.8%Net income $2,645 25% $2,122 70% $1,246 % of net revenue 6.4% 6.0% 4.0%
* * *
Gross Margin
Gross margin as a percentage of net revenue continued to improve in fiscal 2004 to 18.2%, compared to 17.9% in fiscal 2003 and 17.7% in fiscal 2002. The year-over-year improvement for fiscal 2004 and 2003 was primarily driven by Dell’s continued cost savings initiatives. As part of management’s focus on improving margins, Dell remains committed to reducing . . . manufacturing costs, warranty costs . . . and overhead or operating expenses. These cost savings initiatives also include providing certain customer technical support . . . from cost effective locations . . . . [T]he strength of Dell’s direct-to-customer business model . . . makes Dell better positioned than its competitors to continue profitable market share growth in any business climate.
Operating Expenses
* * *
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During fiscal 2004, Dell continued to execute on maximizing operating income dollars by producing record low operating expenses as a percentage of net revenue of 9.7%. The decrease was primarily a result of previously referred to cost reduction initiatives and Dell’s continued focus and execution on cost control.
76. Dell’s F04 10-K also described Dell’s accounting and disclosure controls and
policies:
Critical Accounting Policies
Dell prepares its financial statements in conformity with generally accepted accounting principles in the United States of America (“GAAP”). . . . Dell believes its most critical accounting policies relate to revenue recognition [and] warranty accruals . . . .
* * *
Warranty – Dell records warranty liabilities at the time of sale for the estimated costs that may be incurred under its basic limited warranty. . . . Warranty claims are relatively predictable based on historical experience of failure rates. Each quarter, Dell reevaluates its estimates to assess the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.
77. Dell’s F04 Report on Form 10-K also contained the Sarbanes-Oxley certifications
signed by M. Dell and Schneider detailed at ¶¶269-273.
78. The positive statements made by the Dell Defendants regarding Dell during
11/03-4/12/04 detailed above artificially inflated Dell’s stock price. As Dell’s stock traded at
these artificially inflated levels and Dell’s top executives’ stock options were “in the money,”
Dell insiders unloaded more of their stock to profit from their “pump-and-dump” scheme.
Between 11/24/03 and 4/7/04, they sold off nearly 20 million shares of their Dell stock for $663
million in illegal insider trading proceeds.
79. The statements made between 11/03 and 4/12/04, as pleaded in ¶¶61-77, included:
• Dell was reporting “leading profitability” and “record” financial results, including operating income, operating margins and “quality earnings” that “continue to lead market,” producing “compelling profit[s] for investors” due to Dell’s “high quality, low cost business model.”
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• Dell’s “business model is advantaged in all environments, across all regions and in all product categories” and was enabling Dell “to consistently deliver exceptional financial and operating performance in all environments,” “maximize operating profitably” and to “continue to drive superior results.”
• Investors could “not focus . . . enough” on Dell’s “cost reduction activities.” Dell’s “cost control” and its “cost reduction initiatives” were resulting in record low operating expenses that “drove operating income to new records.” These initiatives included providing “customer support from cost effective locations,” and assuring that “re-routing corporate customer support calls to U.S. call centers” was “routine” and “no big deal,” as Dell’s customers were “satisfied” with Dell’s support and service.
• Dell had “reduced the number of people in its manufacturing process” and had “reduced warranty costs” by 50% while its “direct model” and “efficient manufacturing process” with Dell’s quality control procedures created “high quality products” and “superior service and support,” with products that were “easy to buy” – yielding Dell a “distinct competitive advantage.”
• Dell’s direct model and high quality products generated “100 awards for product and service quality and reliability in the past year,” resulting in Dell being ranked “No. 1 for overall service and support.”
• Dell’s top officers had reviewed Dell’s internal financial and accounting and disclosure controls, which controls were effective to assure accurate preparation of Dell’s SEC filings and that no undisclosed deficiencies in Dell’s internal controls or fraud – material or otherwise – existed at Dell.
These statements impacted and were reflected in the market trading price of Dell’s publicly
traded securities. The statements set forth in ¶¶61-79 were false and misleading. The true
undisclosed facts, which were known to or recklessly disregarded by each of the Dell
Defendants, were:
(a) The Dell Direct business model was not operating successfully or creating
the strong, often record, financial results and operating margins Dell was reporting; in fact, due
to overly aggressive cost-cutting in Dell’s customer support and service and manufacturing
operations, Dell’s business model was being afflicted with sky-rocketing customer
dissatisfaction and complaints, as well as increasing product quality problems (especially with
laptop batteries and capacitors). In truth, Dell’s financial results were being falsified and
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temporarily inflated by (i) large cost-cuts which would have to be reversed and remediated;
(ii) improper accounting tricks, including under-accruing warranty costs and failing to take
timely write-downs for defective products and product replacement; and (iii) its secret receipt of
some $200 million per quarter in rebate/kickback payments from Intel in return for exclusively
purchasing Intel microprocessors/chips.
(b) Dell was not manufacturing or selling the highest quality products, as
Dell’s aggressive cost-cutting in its manufacturing operations to boost its reported profits in the
short term had badly weakened Dell’s quality control procedures and standards for component
parts, i.e., batteries and finished goods, such that Dell was encountering an upsurge in customer
complaints due to faulty products, including capacitor failures, motherboard failures and
widespread laptop (lithium) battery defects.
(c) Dell did not have an unrivaled ability to create products or technologies
that met or exceeded customer expectations, nor did it have world-class manufacturing
excellence, producing high-quality products. In fact, as a result of the aggressive cost cuts in
Dell’s manufacturing operations, Dell’s quality assurance procedures had become badly
impaired, leading to a marked decline in product quality.
(d) Dell’s cost-cutting program was resulting in a marked increase in the
production of defective products which did not meet Dell’s historic quality standards and a
marked decline in Dell’s historic levels of customer support and service and thus customer
satisfaction, which Dell insiders knew would cost hundreds of millions, if not billions, of dollars
to remedy, including the hiring of thousands of additional full-time employees to be trained to
staff customer call centers and to improve Dell’s quality assurance techniques and practices in its
manufacturing operations.
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(e) In order to cut operating costs, Dell had sharply curtailed its quality
control processes by no longer testing component parts (specifically batteries, hard drives,
optical drives or motherboards and laptop accessory parts, including power adaptors) received
from suppliers. Rather, Dell was relying on post-assembly quick tests of completed units to
discover defective component parts. In addition, it had also curtailed the post-assembly “burn-
in” testing of units, which steps in combination were resulting in Dell shipping much larger
numbers of computers with defects and performance problems, leading to increased quality
problems and customer dissatisfaction.
(f) Dell was not providing superior customer service and support as, due to
overly aggressive cost-cutting activities in Dell’s customer support and service operations to
boost its reported profits in the short term, including moving most of Dell’s consumer and small
business customer support and service call centers to India and the Philippines and replacing full-
time, well-trained employees with part-time, ill-trained (but cheaper) employees, Dell’s customer
support and service operations were badly impaired, resulting in very long wait times and an
inability to adequately respond to customer complaints and questions, generating an upsurge in
customer anger and dissatisfaction with Dell, its products and its customer support and service,
which Dell’s internal metrics showed would hurt sales.
(g) Because of its shifting of much of its customer support and service
operations, especially for its consumer and small business customers, to “call centers” in India
and the Philippines and staffing its call centers with part-time, poorly trained employees, Dell
was no longer providing a superior customer experience or generating high degrees of (or
improving) customer satisfaction. Rather, Dell was encountering a widespread customer revolt
with a massive upsurge in complaints regarding declining product quality and declining service
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and support operations and a sharp decline in one of Dell’s key internal metrics – the “likely to
repurchase” number.
(h) The Dell Direct model also was not functioning effectively with respect to
Dell’s direct sales process because Dell had flooded the market with a huge number of confusing
and contradictory promotional offers which its now ill-trained and inadequate sales force was
unable to effectively process. This was leading to refusals to honor many “coupons” and
“promotions,” resulting in customer dissatisfaction and refusal to buy Dell products, which was
showing up in an important internal Dell metric known as the “likely to repurchase” number,
where Dell was seeing soaring negative sentiment which meant customers were displeased with
the Dell sales process and thus Dell’s sales growth would decline.
(i) While Dell publicly disseminated favorable surveys and reports purporting
to show high degrees of Dell customer satisfaction with product quality and service and support,
in fact, its own internal surveys, information and customer metrics (which it constantly
monitored) showed a huge upsurge in customer dissatisfaction with and anger at Dell, including
a measurable increase in negative responses to its most important metric, the so-called “likely to
repurchase” number, which Dell knew indicated serious problems with ongoing sales growth.
(j) Dell’s increasing product quality was not resulting in a decrease in Dell’s
warranty costs. In fact, Dell had quietly curtailed the length of its product warranty and sharply
curtailed the breadth of its warranty coverage (it had eliminated the computer operating system
from its warranty) and, in addition, had secretly adopted a new “fix-on-fail-only” policy,
whereby it would provide in-home repair service or product replacement only when a computer
(or component) completely failed, as opposed to merely malfunctioned, to cut costs. However,
these severe restrictions in Dell’s warranty and service to its customers – which were much
different than Dell’s historic “customer friendly” approach to warranty, service and product
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quality issues – were causing an upsurge in customer dissatisfaction with and anger at Dell,
which Dell insiders knew would inevitably result in declining sales growth and a massive
increase in warranty and product repair costs to try to restore customers’ satisfaction to
acceptable levels.
(k) Dell’s 3rdQ F04, 4thQ F04 and F04 financial results and statements were
artificially inflated and falsified, as detailed in ¶¶233-273, due to a failure to properly accrue
required amounts for warranty costs, failure to recognize material product defect/recall costs and
failure to properly disclose the existence, nature and extent of the huge rebate payments Dell was
receiving each quarter from Intel.
(l) Dell’s Sarbanes-Oxley representations were false, as Dell’s internal
financial and accounting and disclosure controls were deficient and an undisclosed material fraud
was ongoing at Dell – Dell’s financial statements were being falsified, its disclosures in its SEC
filings were false and misleading and an ongoing fraudulent violation of the securities laws was
occurring.
(m) The true reason for Dell’s reported superior operating margins was, in
large part, the hundreds of millions of dollars of secret and likely illegal rebate/kickback
payments Dell was receiving from Intel at the end of each quarter in return for purchasing 100%
or virtually 100% of its microprocessor requirements from Intel.
(n) Due to customer demand for PCs with the advanced features and
advantages of the new AMD microprocessor chips, Dell had decided it would have to begin to
purchase AMD chips for its computers, which would mean the loss of those hundreds of millions
of dollars of rebate/kickback payments from Intel, which would hurt Dell’s operating profits and
margins.
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(o) The Dell Direct business model was not advantaged in all environments
across all regions and in all product categories or able to cause Dell to report solid profits and
rapid growth regardless of prevailing market conditions due to product quality and customer
service and support issues due to the deficiencies and defects detailed above.
(p) Dell’s purported improvements in reducing its operating expenses as a
percentage of net revenues and the reported increases in its net and gross operating profit
margins to record high levels were only being achieved at the cost of the serious product quality
and customer support and service problems outlined above and which the Dell Defendants knew
would require massive expenditures to fix, harming Dell’s profitability going forward.
(q) Due to the material adverse facts and problems set forth above, Dell and
the Dell Defendants knew that Dell could not and would not achieve the revenue, operating
profit, operating profit margins, net income and EPS growth being forecast by them.
80. On 4/12/04, The Wall Street Transcript published an interview with Amy King
and Mike Maher of Dell:
Ms. King (Corporate Spokesperson): First of all, I’d like to comment that we just finished our fiscal year 2004, which was the most successful in our 20-year history. We’ve achieved record-breaking figures in some of the key areas of the company, including unit shipments, revenue, operating and net income and earnings per share. So we’re coming from a very strong base here.
* * *
[B]ut the direct business model is really the key advantage we have compared to our competitors in the industry . . . .
* * *
TWST: Give us the two or three best reasons why at this point the long-term investor should take a very good look at Dell.
Mr. Maher: We have the most efficient business within our industry . . . and our business[es] are very, very healthy.
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81. On 5/13/04, Dell reported record 1stQ F05 (quarter ended 4/30/04) results in a
release, headlined and stating:
Dell’s Continued Strong Growth Outside U.S. Drives Company to Record Q1 Revenue; Dell Anticipates Second-Quarter Sales of $11.7 Billion, EPS 21 Percent Higher
Dell exceeded its own robust worldwide growth expectations while achieving record revenue during fiscal first-quarter 2005.
* * *
The company has now met or exceeded guidance to investors for 13 straight quarters. Net earnings were $731 million, or 28 cents per share, 22 percent higher than a year ago. Dell’s growth in . . . net income has surpassed 20 percent for seven consecutive quarters.
1st Quarter FY ‘05 FY ‘04 Change
Revenue $11,540 $9,532 21% Operating Income $966 $811 19% Net Income $731 $598 22% EPS $.28 $.23 22%
“In our industry, only Dell simultaneously creates great customer value, rapid growth and solid profitability,” said Kevin Rollins, the company’s president and chief operating officer. . . .
First-quarter operating income was $966 million, up 19 percent from a year ago despite higher-than-expected costs for random-access memory late in the quarter. Operating expenses as a percent of revenue were 9.6 percent, matching a company low and better than 9.8 percent last year.
82. On 5/13/04, Dell held a conference call for analysts, money managers and
institutional investors to discuss Dell’s business and its 1stQ F05 results. During the call, the
fact that Dell’s gross margins had declined very slightly was discussed and the following
occurred:
[Schneider – CFO, Sr. VP:] . . . During Q1 . . . [w]e grew . . . EPS more than 20% year over year. . . . Our model consistently delivers growth in all products and regions which is accretive with shareholder value. . . . [W]e delivered 28 cents in earnings per share. An increase of 22% year over year.
* * *
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[Rollins – President, COO:] . . . Q1 was another impressive quarter for Dell. We again hit our financial targets representing the 13th consecutive quarter of delivering on our guidance to investors. . . . And in a recently completed Harris survey, 83% of customers were either satisfied or very satisfied with buying consumables direct from Dell, versus 66% being satisfied who bought through retail.
* * *
[Wagonfeld – First Albany Capital:] . . . I was wondering on the margins, your gross margins were their lowest in seven quarters and the on margins, although they were flat sequentially in all regions they were down about 15 basis points sequentially in the Americas business. So I’m wondering if there is something about pricing maybe particularly in that market that also contributed to the gross margin impact aside from the component costs?
* * *
[Schneider – CFO, Sr. VP:] . . . 10, 20 basis points up or down in margin or in op-ex or in operating income I think is something that you shouldn’t worry about too much.
* * *
[Rollins – President, CEO:] . . . In closing, [we] have clearly demonstrated that the Dell model works in all environments. . . . [The] Dell model continues to win with our growth progressing faster than planned . . . .
83. On 5/14/04, Needham issued a report on Dell discussing the recent conference
call:
Dell reported first quarter results inline with guidance – earnings per share of $0.28 on revenues of $11.54 billion. An after hours sell off of the stock reflects a misunderstanding of the Dell model.
* * *
• The sharp sell off of Dell’s share price in after hours reflects a misunderstanding of the Dell model. Investors appeared to expect an upside earnings surprise. We viewed such a surprise as virtually impossible since the company updated guidance at its analysts meeting just three weeks before the quarter ended. Investors also appeared to be concerned with a 0.2% sequential decline in the company’s gross margin and a 0.1% decline in its operating margin. An unexpected spike in memory prices caused a portion of the gross margin decline in the month of April.
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• Dell has so much control over its model that it can fine tune its pricing to deliver exactly on its guidance. Against the background of the constraint imposed by its earnings guidance, the company can vary its pricing to accelerate or decelerate revenue growth. As a result, minor perturbations in its margin structure mean nothing within the context of its manipulation of the model to deliver on guidance.
84. On 6/9/04, Dell filed its 1stQ F05 report on Form 10-Q with the SEC, signed by
Davis. It contained the same financial results reported earlier and said:
[O]perating expenses remained at a record low 9.6% of net revenue. During the first quarter, Dell continued its focus on maximizing operating profit with operating income and net income of $966 million and $731 million, respectively. . . . Dell’s low-cost structure and efficient direct-to-customer model have enabled the company to consistently achieve year-over-year market share growth while maximizing operating profitability.
During the first quarter of fiscal 2005, Dell . . . utilized its direct-to-customer model to drive down costs through efficient supply chain management. Dell’s model inherently provides cost advantages in manufacturing, operations, and its supply chain.
* * *
Results of Operations
The following table summarizes the results of Dell’s operations for the three months ended April 30, 2004 and May 2, 2003:
Three Months Ended 4/30/04 5/2/03
Dollars % of NetRevenue
Dollars
% of Net Revenue
(dollars in millions)
Net revenue $11,540 100% $9,532 100%Gross margin $2,073 18.0% $1,748 18.3%Operating expenses $1,107 9.6% $937 9.8%Operating income $966 8.4% $811 8.5%Net income $731 6.3% $598 6.3%
Gross Margin
* * *
As part of management’s focus on striving to improve margins, Dell remains committed to reducing . . . manufacturing costs, warranty costs . . . and overhead or operating expenses. These cost savings initiatives also include
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providing certain customer technical support . . . from cost effective locations . . . .
Operating Expenses
* * *
During the first quarter, Dell maintained its record low operating expenses as a percentage of net revenue of 9.6%, compared to 9.8% in the same quarter last year. The decrease was primarily a result of previously referred to cost reduction initiatives.
85. Dell’s 1stQ F05 report on Form 10-Q also contained the Sarbanes-Oxley
certifications signed by Schneider and M. Dell, detailed at ¶¶269-273.
86. On 7/1/04, JP Morgan issued a report on a meeting with Dell CFO Schneider,
reporting what he had told JP Morgan:
• We met with Dell’s CFO, James Schneider, yesterday. . . . [T]he tone of the meeting was positive. Growth expectations remain intact . . . .
* * *
• Dell remains optimistic about its growth prospects . . . .
87. On 8/12/04, Dell issued a release reporting its 2ndQ F05 results, including record
EPS, and increasing operating profit margins, stating:
Dell Second Quarter Revenue Up 20 Percent, EPS 29 Percent Higher . . .
* * *
Dell revenue was $11.7 billion, a company record and 20 percent higher than in the same quarter a year ago. . . .
Earnings per share were 31 cents, 29 percent higher and also a Dell record. . . .
2nd Quarter Year to Date
FY ‘05 FY ‘04 Change FY ‘05 FY ‘04 Change
Revenue $11,706 $9,778 20% $23,246 $19,310 20%Operating Income $1,006 $840 20% $1,972 $1,651 19%Net Income $799 $621 29% $1,530 $1,219 26%EPS $.31 $.24 29% $.59 $.47 26%
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“We start with the marketplace advantage of a more efficient, more customer-focused way of doing business,” said Kevin Rollins, Dell’s chief executive officer. “And our global team is consistently disciplined in applying that business model.”
* * *
In the most-recent quarter, operating expenses were 9.6 percent of revenue, equaling a company low. Operating profit as a percent of revenue was 8.6 percent, up from 8.4 percent in the year’s first quarter.
88. On 8/12/04, Dell held a conference call for analysts, money managers and
institutional investors to discuss Dell’s business and its 2ndQ F05 results. During the call, the
following occurred:
[Schneider – CFO, SVP:] . . . In Q2 we posted record revenue with double-digit growth across all products, segments, and regions, coupled with enhanced overall profitability. Quarterly operating income was in excess of $1 billion, a company record. We delivered improved margin sequentially . . . . Earnings per share increased 29%. . . . [W]e . . . overachieved on EPS hitting 31 cents. . . . We improved our operating margin by over 20 basis points sequentially to 8.6% . . . .
* * *
[Rollins – President, CEO:] . . . In Q2 Dell again demonstrated consistency of execution as we hit our guidance to investors for the 14th consecutive quarter. Our strategy of driving profitable share growth is working exceptionally well and we continue to outperform the market. We’re ahead of our $60 billion target . . . This is unprecedented organic growth for a company of our size in any industry and we did it while driving our margins higher. We achieved these results by leveraging the core advantages of our model . . . . Each quarter we identify businesses with the most attractive revenue and profit profiles, then the structural advantages of the Dell model, combined with disciplined execution allow us to address these opportunities. . . . And our cost advantages allow us to drive profitable growth by offering superior value . . . . It’s clear that our ability to generate superior returns remains unmatched.
* * *
[Schneider – CFO, SVP:] . . . [O]ur model continues to deliver exceptional financial and operating results in any environment.
89. On 8/12/04, Raymond James issued a report on Dell based on the recent
conference call:
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DELL: Raising FY06 EPS Estimates Due to Better Margins
• Dell’s 2Q results ending July were in-line with revised expectations. During the period . . . operating income rose 20% to $1.01 billion; and EPS of $0.31 compared with $0.24 last year. . . .
• . . . Gross margin improve sequentially to 18.2% from 18.0% and returned to more normal levels . . . .
* * *
• . . . We are raising our FY06 Estimate to $1.54 from $1.52 to reflect a faster than expected pace of improvement in operating margin and continued strength in the core US business.
90. On 8/12/04, Thomas Weisel Partners issued a report on Dell based on the recent
conference call:
• Execution separates Dell from the pack. . . . [G]ross margin of 18.2%, operating margin of 9.0%, and EPS of $0.31 were all exactly in line with our and Street estimates.
* * *
• Gross margin improvement due mainly to decline in component prices – leading to EPS upside. Gross margin of 18.2% came in line with our expectation.
91. On 8/13/04, Bear Stearns issued a report on Dell based on the recent conference
call.
*** Why is Dell doing well? Primarily due to its advantaged, direct model which keeps it close to customers [and] provides lower costs . . . .
92. On 8/17/04, CSFB issued a report “initiating coverage” on Dell. The report
stated:
Initiate Coverage with an Outperform Rating
* * *
Outlook. We believe Dell owns a sustainable competitive advantage due to its direct model, and we expect the company to deliver superior growth and attractive financial returns in the foreseeable future.
* * *
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By selling PCs directly, Dell establishes a strong rapport with both its consumer and corporate customers, listening to suggestions and concerns in order to gain a better understanding of buying behavior. . . . By knowing its customers, Dell is able to react quickly to changes in customer preferences and can avoid producing products for which demand does not meet supply. In short, having access to better information than its competitors gives the company a significant competitive advantage.
93. On 9/7/04, Dell filed its 2ndQ F05 Report on Form 10-Q with the SEC, signed by
Davis. It contained the same financial results earlier reported and stated:
Second Quarter Overview
. . . During the second quarter of fiscal 2005, Dell’s year-over-year performance continued to outpace the industry. . . . [O]perating expenses remained at a record low 9.6% of net revenue. During the second quarter, Dell achieved quarterly operating income that exceeded $1.0 billion for the first time . . . .
Dell’s low-cost structure and efficient direct-to-customer model have enabled the company to consistently . . . maximiz[e] operating profitability. . . . Dell’s model inherently provides cost advantages in manufacturing, operations, and its supply chain.
* * *
Results of Operations
The following table summarizes the results of Dell’s operations for the three and six months ended July 30, 2004 and August 1, 2003:
Three Months Ended Six Months Ended (dollars in millions)
7/30/04 8/1/03 7/30/04 8/1/03
Dollars % of Net Revenue
\ Dollars
% of Net Revenue
Dollars
% of Net Revenue
Dollars
% of Net Revenue
Net revenue $11,706
100% $9,778 100% $23,246 100% $19,310 100%
Gross margin $2,134
18.2% $1,778 18.2% $4,207 18.1% $3,526 18.3%
Operating expenses $1,128
9.6% $938 9.6% $2,235 9.6% $1,875 9.7%
Operating income $1,006
8.6% $840 8.6% $1,972 8.5% $1,651 8.6%
Net income $799 6.8% $621 6.3% $1,530 6.6% $1,219 6.3%
* * *
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Gross Margin
Gross margin as a percentage of net revenue remained constant at 18.2% during the second quarter of fiscal 2005, as compared to the second quarter of fiscal 2004. . . . Management believes that the strength of Dell’s direct-to-customer business model . . . makes Dell better positioned than its competitors to gain market share in any business climate.
As part of management’s focus on striving to improve margins, Dell remains committed to reducing . . . manufacturing costs, warranty costs . . . and operating expenses. These cost savings initiatives also include providing certain customer technical support . . . functions from cost-effective locations . . . .
94. Dell’s 2ndQ F05 report on Form 10-Q also contained the Sarbanes-Oxley
certifications signed by Schneider and Rollins, detailed at ¶¶269-273.
95. On 9/8/04, Rollins appeared at the Smith Barney Technology Conference.
Citigroup reported what Rollins said:
Dell President and CEO Kevin Rollins commented that Dell has seen nothing that would prompt it to change the revenue or earnings guidance provided on its most recent earnings call.
Rollins also expressed optimism regarding the rate of decline in the price of key components, which has a material impact on Dell’s relative cost advantage.
96. On 9/15/04, Dell held a conference call for analysts, money managers and
institutional investors to discuss Dell’s U.S. consumer business.
[Hamlin – SVP, US Consumer Business:] Our U.S. consumer business has achieved tremendous success . . . . Our growth has been driven by the strength of the direct model, superior customer value, and increasing brand performance and loyalty among our customers. This success is evidenced by our strong operating results . . . . Dell offers a compelling value for customers by providing high-quality technology at an affordable price and standing behind the product with leading customer service and support. As a result of this focus consumers are indicating an increasing level of broad preference for Dell. . . . Dell’s focus on disciplined profitable growth will continue to yield superior results in the consumer market, regardless of the operating environment.
* * *
[George – VP and General Manager, US Consumer Business:] A key component of our success and our ongoing strategy has been our commitment to the highest quality of service and support. Dell has consistently rated among the
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best in the industry at providing service and support to customers. . . . We believe that the direct model is the best approach for providing the highest quality service and support.
97. The positive statements made by defendants regarding Dell during 4/04-9/04
continued to artificially inflate Dell’s stock. As Dell’s stock traded at these artificially inflated
levels, Dell’s top executives’ Dell stock options remained “in the money.” Dell insiders
unloaded more of their stock to profit from their “pump-and-dump” scheme. Between 5/18/04-
10/5/04, they sold off 23.4 million shares of their Dell stock for $823 million in illegal insider
trading proceeds.
98. On 11/11/04, Dell reported its 3rdQ F05 results – its “best reporting period in its
history” – via a release stating:
Record global product shipments, revenue, operating and net income, earnings per share and cash from operations made Dell’s fiscal third-quarter 2005 the best reporting period in its history.
* * *
Earnings per share were 33 cents, up 27 percent, for the quarter ended Oct. 29:
3rd Quarter Year to Date (in millions)
FY ‘05 FY ‘04 Change FY ‘05 FY ‘04 Change
Revenue $12,502 $10,622 18% $35,748 $29,932 19%Operating Income $1,095 $912 20% $3,067 $2,563 20%Net Income $846 $677 25% $2,376 $1,896 25%EPS $.33 $.26 27% $.92 $.72 28%
“The record quarter is testament to the company’s superb team executing a better business model,” said Kevin Rollins, Dell chief executive officer. “An improving component-cost environment further favors Dell, with customers and shareholders the primary beneficiaries.”
* * *
In the third quarter, Dell’s operating profit improved to 8.8 percent of revenue, the company’s highest rate in four years.
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99. On 11/11/04, Dell held a conference call for analysts, money mangers and
institutional investors to discuss its 3rdQ F05 results. During the call, the following occurred:
[Schneider – SVP & CFO:] We’re extremely pleased with our overall performance and the team’s execution during third quarter. We leveraged the unique strengths of our model to deliver enhanced profitability and record performance across our business. Let me list a few. . . . [O]perating and net income [and] EPS . . . were all company records. . . . Turning to our financials, we had industry-leading performances across the board. We delivered EPS of 33 cents, an increase of 27 percent year-over-year . . . . Our operating margins grew to 8.8 percent, up 20 basis points sequentially and 40 basis points since the first quarter.
* * *
[Rollins – CEO:] For the 15th consecutive quarter we met or beat our guidance to investors. . . . [W]e’re now almost a full year ahead of our $60 billion objective.
* * *
[Conigliaro – Goldman Sachs – Analyst:] You indicated that you are ahead of your goal to achieve the $60 billion in revenue that you targeted. In fact, you were quoted in a Bloomberg article saying that you actually are 12 months ahead of schedule. I guess I’d like a little more clarification on that.
* * *
[Rollins – CEO:] Our trajectories in growth revenue has been in the 18 to 20 percent range on and off throughout this year quarter-to-quarter. We don’t see any reason to believe that the trajectory of our growth rate is going to slow . . . . So given that, our confidence in hitting some pretty good numbers is increasing. . . . [W]e’re trying to let you know that we’re ahead of plan. . . . [W]e see no reason to change or that will have to change the growth trajectory we’ve been experiencing.
100. On 11/11/04, Bear Stearns issued a report on Dell based on the recent conference
call:
Dell Inc. – Outperform In-Line Results And Outlook; Strong Growth Overseas Highlights Future Opportunity; Raising FY06 Estimates; Reiterate Outperform
* * *
*** Dell reported another solid quarter with its results and guidance as expected, showing balanced growth and particular strength overseas where we see further
- 100 -
headroom for growth and margin upside . . . . We are raising our estimates for FY06.
* * *
• Gross Margin Above Expectations. Gross margin of 18.5% was above our forecast of 18.2%, up almost 30 basis points sequentially and from the year-ago period . . . .
* * *
Raising FY06 Estimates; Initiating FY07 Estimates. For FY06, we are raising our EPS estimate from $1.55 to $1.58 . . . . CEO Kevin Rollins noted that Dell is confident about maintaining the 18%-20% annual revenue growth it has seen for the past year. For FY07, we are initiating a FY07 EPS estimates of $1.85 . . . .
101. On 11/12/04, Bloomberg reported:
Rollins’s remarks cheered investors . . . and Rollins said for the second time in a week that Dell will meet the $60 billion sales goal a year earlier than planned.
* * *
“Our confidence in hitting some pretty good numbers is increasing . . . . We’re trying to let you know we’re ahead of plan. The growth rates appear to be achievable.”
102. On 11/12/04, The Los Angeles Times reported:
Record sales of computing products and systems . . . propelled Dell Inc. to a 25% increase in profit in its best quarter ever.
* * *
Dell shares, which gained 40 cents to $37.25 in regular Nasdaq trading, rose to $38.02 in extended trading after the quarterly results were announced.
“They’re just hitting on all cylinders,” said James Ragan, an analyst with Crowell, Weedon & Co. in Los Angeles. “Business in strong, their business model is very favorable . . . .”
* * *
“It was very upbeat. It was record everything,” said Mark Stahlman, an analyst in New York with San Diego-based investment bank Caris & Co. . . .
* * *
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“[W]e think the 60 billion is within reach about a year early,” Rollins told analysts . . . .
103. On 11/12/04, UBS issued a report on Dell based on the recent conference call:
In Line 3Q & Outlook, FY06 View Surprises
• Reports in Line With Expectations
. . . Gross margins exceeded our estimates by 20 bps at 18.5% due to lower component pricing.
• $60B In 2006 On 18%-20% Growth?
While Dell reported as we expected in terms of performance, commentary & an in-line outlook, we were surprised to hear that it expects to grow 18-20% in FY06 – which would be impressive.
* * *
4. Component Price Boost Margins. Dell reported gross margins of 18.5% in the quarter, beating our 18.2% estimate.
104. On 11/12/04, Piper Jaffrey issued a report on Dell based on the recent conference
call:
• Dell reported its 3FQ05 earnings results yesterday . . . . Robust growth across every segment and a declining component cost environment enabled the Company to meet both our and consensus estimates of $12.5B and $0.33. Gross margins of 18.5% beat our estimates . . . .
• Our takeaway from the earnings report and conference call is that the Dell revenue and earnings growth trajectory has not slowed and shows no signs of slowing in the near future. The Company indicated that it was executing ahead of plan to achieve $60B in annual revenues . . . .
• The Dell model continues to outperform . . . .
105. On 11/12/04, CIBC Issued a report on Dell based on the recent conference call:
Revisiting our Thesis: Dell Gains Are Defying Gravity, Should Help Sustain Premium in Shares
Controversy regarding the sustainability of Dell’s margins and growth rates, underlying our prior Sector Performer rating, should take a back seat following bullish guidance on strength of end-markets, and on Dell’s ability to maintain its market-share momentum.
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* * *
Overall, with gross margins on an upswing, and next-round scalability of operating margins (after 40 bps gains this year) probably no more than nine months away, evidence suggests that tailwind of declining component prices is in fact allowing Dell to execute on its lean inventory and dynamic sourcing models.
106. On 12/1/04, Dell filed its 3rdQ F05 Report on Form 10-Q, signed by Davis. It
reported:
Third Quarter Overview
. . . Dell maximized its operating profitability with operating income increasing 20% year-over-year to a record $1.1 billion. Dell’s gross profit margin of 18.5% and operating margin of 8.8% reached the highest levels in four years. . . .
Dell’s low-cost structure and efficient direct-to-customer model have enabled the company to consistently achieve year-over-year market share growth while maximizing operating profitability. . . . Dell’s model inherently provides cost advantages in manufacturing, operations, and its supply chain.
* * *
Results of Operations
The following table summarizes the results of Dell’s operations for the three and nine months ended October 29, 2004 and October 31, 2003:
Three Months Ended Six Months Ended (dollars in millions)
10/29/04 10/31/03 10/29/04 10/31/03
Dollars % of Net Revenue
Dollars
% of Net Revenue
Dollars
% of Net Revenue
Dollars
% of Net Revenue
Net revenue Gross margin Operating expenses Operating income
$12,502
$2,313
$1,218
$1,095
100%
18.5%
9.7%
8.8%
$10,622
$1,935
$1,023
$912
100%
18.2%
9.6%
8.6%
$35,748
$6,520
$3,453
$3,067
100%
18.2%
9.7%
8.6%
$29,932
$5,461
$2,898
$2,563
100%
18.2%
9.7%
8.6%
Net income $846
6.8% $677 6.4% $2,376 6.6% $1,896 6.3%
* * *
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Gross Margin
Gross margin as a percentage of net revenue increased to 18.5% during the third quarter of fiscal 2005, compared to 18.2% during the third quarter of fiscal 2004. . . .
As part of management’s focus on striving to improve margins, Dell remains committed to reducing . . . manufacturing costs, warranty costs . . . and operating expenses. These cost savings initiatives include providing certain customer technical support . . . functions from cost-effective locations . . . .
Three Months Ended Nine Months Ended (dollars in millions)
10/29/04 10/31/03 10/29/04 10/31/03
Dollars % of Net Revenue
Dollars
% of Net Revenue
Dollars
% of Net Revenue
Dollars
% of Net Revenue
Selling, general and administrative Research, development and engineering
$1,101
$117
8.8%
0.9%
$905
$118
8.5%
1.1%
$3,100
$353
8.7%
1.0%
$2,553
$345
8.5%
1.2%
Total operating expenses
$1,218
9.7% $1,023 9.6% $3,453 9.7% $2,898 9.7%
107. Dell’s 3rdQ F05 report on Form 10-Q also contained the Sarbanes-Oxley
certifications signed by Schneider and Rollins, detailed at ¶¶269-273.
108. On 12/9/04, S.G. Cowen & Co. issued a report on Dell based on a meeting with
Rollins, repeating what Rollins had said:
Bullish CEO Meeting: We See Poised for 20%+/Annum EPS Growth Next Two Years
Conclusion: We hosted Dell CEO Kevin Rollins at a Boston investor lunch meeting yesterday. It seems apparent that the Dell execution engine is running essentially on all cylinders. Current demand is strong . . . . We are raising estimates . . . .
109. The positive statements made by defendants regarding Dell during 11/04-12/04
artificially inflated Dell’s stock, which reached its Class Period high of $42.57 on 12/9/04. As
Dell’s stock traded at these artificially inflated levels, Dell’s top executives’ stock options were
“in the money.” Dell insiders unloaded more of their stock to profit from their “pump-and-
dump” scheme. Between 11/16/04 and 12/20/04, they sold off 13 million shares of their Dell
stock for $528 million in illegal insider trading proceeds.
- 104 -
110. On 1/7/05, Bear Stearns issued a report based on conversations with members of
Dell’s management at corporate headquarters, repeating what they said:
*** After meeting with Dell management . . . our takeaway was that Dell continues to be a solid growth story . . . driving strong revenue growth and with potential for margin expansion over time. CEO Kevin Rollins noted Dell’s confidence in 17%-20% revenue growth range in the foreseeable future.
111. On 2/10/05, Dell issued a release reporting Dell’s record 4thQ F05 and F05
results, via a release headlined and stating:
Record Revenue, Shipments, Operating Income and Cash Flow Highlighted Dell’s Fiscal Fourth Quarter; Revenue up 17 Percent, Earnings Exceed Company Guidance
Strong growth throughout Dell’s diversified range of products and services in the fiscal fourth-quarter 2005 led to the company’s best ever operating period. The company achieved quarterly records for . . . operating income . . . .
* * *
Pro-forma fourth-quarter net earnings were 37 cents per share, 28 percent higher than last year. That exceeded Dell’s guidance . . . .
Dell’s fourth-quarter reported earnings were $667 million, or 26 cents per share, which included a tax charge of 11 cents per share. The charge was taken in anticipation of repatriating foreign earnings at a one-time favorable tax rate under the U.S. American Jobs Creation Act (AJCA).
* * *
Full-year pro-forma earnings were $1.29 per share, up 28 percent; fiscal-2005 reported earnings, including the AJCA-related charge, were $1.18 per share. Full-year revenue was $49.2 billion, up 19 percent.
“The quarter represents continued record performance by our team around the world,” said Kevin Rollins, Dell’s chief executive officer. . . .
* * *
In the fourth quarter, Dell’s operating margins improved to 8.8 percent, up from 8.5 percent a year ago.
112. On 2/10/05, Dell held a conference call for analysts, money managers and
institutional investors to discuss its F05 results. During the call, the following occurred:
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[Schneider – CFO, SVP:] . . . Our fourth quarter results capped a year in which Dell delivered strong performance and records across the board, including unit shipments, revenues, operating income, EPS, and cash flow from operations. Looking at our results for the full year . . . [o]ur operating income was up 20 percent to $4.3 billion resulting in an operating margin over 8.6 percent. The highest level in 4 years. We generated pro forma EPS of $1.29, up 28 percent. . . . [F]or the fourth quarter, we delivered EPS of $0.37, an increase of 28 percent year-over-year . . . .
* * *
[Rollins – President, CEO:] . . . Our fourth quarter closed out another great year of strong growth for Dell. We have now met or beat our guidance to investors for 16 consecutive quarters, demonstrating a consistency of execution that is unmatched in our industry. Our strategy of profitable growth, delivering earnings per share[,] . . . continues to deliver superior value to our customers and our shareholders. . . . The Dell model, which is uniquely able to offer the highest quality products and services while maintaining the most efficient cost structure has consistently benefited from this consolidation.
113. On 2/10/05, Bear Stearns issued a report on Dell based on the recent conference
call. It stated:
Dell Inc. – Outperform; Solid Results And Outlook; Poised To Benefit From Competitive Dislocation; Raising Estimates; Reiterate Outperform Rating
Key Points
. . . [I]t was a typical Dell quarter (16th in a row in line or above expectations), highlighting Dell’s above-average, profitable growth . . . .
. . . [M]anagement was confident that its growth trajectory was intact . . . .
* * *
*** We’re raising our estimates for FY06 from $1.58 to $1.60 in EPS (vs. $1.28 in FY05) . . . and for FY07 from $1.85 to $1.90 in EPS . . . .
* * *
• Gross Margin Above Expectations. Gross margin of 18.5% was above our forecast of 18.4%, up 5 basis points sequentially and 20 basis points from the year-ago period, owing to . . . more favorable component cost declines . . . .
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114. On 2/11/05, The Wall Street Journal reported “Dell Retakes Lead in Strong
Quarter . . . Operating Profit Rises; H-P Trails in Global Sales”:
Computer maker Dell Inc. said its fiscal fourth-quarter . . . operating earnings jumped 21%.
Dell’s robust performance, slightly above Wall Street expectations, underscored the dependable success of Dell’s low-cost, direct-sales strategy.
* * *
Kevin B. Rollins, Dell’s chief executive, called the quarter “the best operating period in Dell’s history.”
* * *
Dell’s relentless efforts to cut costs, using Internet sales and build-to-order inventory management, has allowed it to compete aggressively on price while continuing to increase its profits. Dell has encouraged investors with ebullient forecasts in recent quarters, building expectations that its robust growth will continue unabated.
115. On 2/24/05, The Wall Street Journal reported on Dell’s intent to retain Intel as its
sole source of supply of chips:
Dell Is Likely to Keep Intel Pact
Dell Inc. Chief Executive Kevin Rollins said the personal-computer giant is unlikely to add Advanced Micro Devices Inc. as a chip supplier . . . .
Dell has long used only Intel chips. Mr. Rollins, speaking at an investor conference in Phoenix hosted by Goldman Sachs, said Dell considered changing that practice as AMD products became more competitive and Intel suffered a series of technical slip-ups last year. But Intel responded, Mr. Rollins said, and has improved its “roadmap” of new products, to the point that Dell probably won’t change its Intel-only purchasing policy.
116. The statements made between 4/04-2/05 as pleaded above included:
• Dell reported “record breaking,” i.e., its “best ever,” financial results. Its businesses were “very, very healthy,” its growth “was progressing faster than planned,” and was “unprecedented organic growth for a company of our size,” achieved due to the “core advantages of [our] model.” Dell’s “ability to generate superior returns remains unmatched,” all due to a model that “delivers exceptional financial and operating results in any environment,” leaving Dell “ahead of [its] $60 billion target” – “well ahead of plan” – all a “testament to our better business model.”
- 107 -
• Dell’s model “works in all environments,” “continues to win,” “maximizes operating profitability” and was the “best approach for producing highest quality service and support,” “delivering growth which is accretive to shareholder value.”
• Dell was “providing customer support from cost effective locations,” yielding 83% “customer satisfied” or “very satisfied” responses, compared to just 66% of customers dealing with retail outlets, and Dell’s model was “uniquely able to deliver the highest quality products.”
• Dell’s top officers had reviewed Dell’s internal financial and accounting and disclosure controls. Those controls were effective to assure accurate preparation of Dell’s SEC filings and that no undisclosed deficiencies in Dell’s internal controls or fraud – material or otherwise – existed at Dell.
These statements impacted and were reflected in the market trading price of Dell stock. The
statements set forth in ¶¶80-116 were false and misleading. The true undisclosed facts, which
were known to or recklessly disregarded by each of the Dell Defendants, were:
(a) The Dell Direct business model was not operating successfully or creating
the strong, often record, financial results and operating margins Dell was reporting; in fact, due
to overly aggressive cost-cutting in Dell’s customer support and service and manufacturing
operations, Dell’s business model was being afflicted with sky-rocketing customer
dissatisfaction and complaints, as well as increasing product quality problems (especially with
laptop batteries and capacitors). In truth, Dell’s financial results were being falsified and
temporarily inflated by (i) large cost-cuts which would have to be reversed and remediated; (ii)
improper accounting tricks, including under-accruing warranty costs and failing to take timely
write-downs for defective products and product replacement; and (iii) its secret receipt of some
$200 million per quarter in rebate/kickback payments from Intel in return for exclusively
purchasing Intel microprocessors/chips.
(b) Dell was not manufacturing or selling the highest quality products, as
Dell’s aggressive cost-cutting in its manufacturing operations to boost its reported profits in the
short term had badly weakened Dell’s quality control procedures and standards for component
- 108 -
parts, i.e., batteries and finished goods, such that Dell was encountering an upsurge in customer
complaints due to faulty products, including capacitor failures, motherboard failures and
widespread laptop (lithium) battery defects.
(c) As a result of the aggressive cost cuts in Dell’s manufacturing operations,
Dell’s quality assurance procedures had become badly impaired, leading to a marked decline in
product quality.
(d) Dell’s cost-cutting program was resulting in a marked increase in the
production of defective products which did not meet Dell’s historic quality standards and a
marked decline in Dell’s historic levels of customer support and service and thus customer
satisfaction, which Dell insiders knew would cost hundreds of millions, if not billions, of dollars
to remedy, including the hiring of thousands of additional full-time employees to be trained to
staff customer call centers and to improve Dell’s quality assurance techniques and practices in its
manufacturing operations.
(e) In order to cut operating costs, Dell had sharply curtailed its quality
control processes by no longer testing component parts (specifically batteries, hard drives,
optical drives or motherboards and laptop accessory parts, including power adaptors) received
from suppliers. Rather, Dell was relying on post-assembly quick tests of completed units to
discover defective component parts. In addition, it had also curtailed the post-assembly “burn-
in” testing of units, which steps in combination were resulting in Dell shipping much larger
numbers of computers with defects and performance problems, leading to increased quality
problems and customer dissatisfaction.
(f) Dell was not providing superior customer service and support as, due to
overly aggressive cost-cutting activities in Dell’s customer support and service operations to
boost its reported profits in the short term, including moving most of Dell’s consumer and small
- 109 -
business customer support and service call centers to India and the Philippines and replacing full-
time, well-trained employees with part-time, ill-trained (but cheaper) employees, Dell’s customer
support and service operations were badly impaired, resulting in very long wait times and an
inability to adequately respond to customer complaints and questions, generating an upsurge in
customer anger and dissatisfaction with Dell, its products and its customer support and service,
which Dell’s internal metrics showed would hurt sales.
(g) Because of its shifting of much of its customer support and service
operations, especially for its consumer and small business customers, to “call centers” in India
and the Philippines and staffing its call centers with part-time, poorly trained employees, Dell
was no longer providing a superior customer experience or generating high degrees of (or
improving) customer satisfaction. Rather, Dell was encountering a widespread customer revolt
with a massive upsurge in complaints regarding declining product quality and declining service
and support operations and a sharp decline in one of Dell’s key internal metrics – the “likely to
repurchase” number.
(h) While Dell publicly disseminated favorable surveys and reports purporting
to show a high degree of Dell customer satisfaction with product quality and service and support,
in fact, its own internal surveys, information and customer metrics (which it constantly
monitored) showed a huge upsurge in customer dissatisfaction with and anger at Dell, including
a measurable increase in negative responses to its most important metric, the so-called “likely to
repurchase” number, which Dell knew indicated serious problems with ongoing sales growth.
(i) Dell had quietly curtailed the length of its product warranty and sharply
curtailed the breadth of its warranty coverage (it had eliminated the computer operating system
from its warranty) and, in addition, had secretly adopted a new “fix-on-fail-only” policy,
whereby it would provide in-home repair service or product replacement only when a computer
- 110 -
(or component) completely failed, as opposed to merely malfunctioned, to cut costs. However,
these severe restrictions in Dell’s warranty and service to its customers – which was much
different than Dell’s historic “customer friendly” approach to warranty, service and product
quality issues – were causing an upsurge in customer dissatisfaction with and anger at Dell,
which Dell insiders knew would inevitably result in declining sales growth and a massive
increase in warranty and product repair costs to try to restore customers’ satisfaction to
acceptable levels.
(j) Dell’s 1stQ, 2ndQ, 3rdQ and 4thQ F05 and F05 financial results and
statements were artificially inflated and falsified, as detailed in ¶¶233-273, due to a failure to
properly accrue required amounts for warranty costs, failure to recognize material product
defect/recall costs and failure to properly disclose the existence, nature and extent of the huge
rebate payments Dell was receiving each quarter from Intel.
(k) Dell’s Sarbanes-Oxley representations were false, as Dell’s internal
financial and accounting and disclosure controls were deficient and an undisclosed material fraud
was ongoing at Dell – Dell’s financial statements were being falsified, its disclosures in its SEC
filings were false and misleading and an ongoing fraudulent violation of the securities laws was
occurring.
(l) Dell’s statements regarding its ability to quickly benefit financially from
declines in component part prices was false and misleading. The true reason for Dell’s reported
superior operating margins was, in large part, the hundreds of millions of dollars of secret and
likely illegal rebate/kickback payments Dell was receiving from Intel at the end of each quarter
in return for purchasing 100% or virtually 100% of its microprocessor requirements from Intel.
(m) Due to customer demand for PCs with the advanced features and
advantages of the new AMD microprocessor chips, Dell had decided it would have to begin to
- 111 -
purchase AMD chips for its computers, which would mean the loss of those hundreds of millions
of dollars of rebate/kickback payments from Intel, which would hurt Dell’s operating profits and
margins.
(n) The Dell Direct business model was not advantaged in all environments
across all regions and in all product categories or able to cause Dell to report solid profits and
rapid growth regardless of prevailing market conditions due to product quality and customer
service and support issues due to the deficiencies and defects detailed above.
(o) Dell’s purported improvements in reducing its operating expenses as a
percentage of net revenues and the reported increases in its net and gross operating profit
margins to record high levels were only being achieved at the cost of the serious product quality
and customer support and service problems outlined above and which the Dell Defendants knew
would require massive expenditures to fix, harming Dell’s profitability going forward.
(p) Due to the material adverse facts and problems set forth above, Dell and
the Dell Defendants knew that Dell could not and would not achieve the revenue, operating
profit, operating profit margins, net income and EPS growth being forecast by them.
117. During the first half of 3/05, information became public that Intel was violating
the antitrust laws by paying huge kickbacks to customers (computer manufacturers) to get them
to buy microprocessor chips only from Intel. For instance:
(a) On 3/4/05, Japanese regulators had determined that Intel was violating
Japan’s antitrust laws by paying secret rebates, i.e., kickbacks, to Japanese computer
manufacturers in return for their purchasing microprocessors exclusively from Intel. A report
stated:
Japan’s Fair Trade Commission will rule against a local unit of the world’s leading microchip maker Intel Corp. over suspected violation of anti-monopoly laws, a report said Friday.
- 112 -
Intel has been under investigation on allegations that it pressured its customers to limit their procurement from rival firms in exchange for discounts on Intel products.
(b) On 3/7/05, the San Jose Mercury News reported on the Japanese antitrust
proceeding against Intel:
Japan reportedly accuses Intel of antitrust violations
Japanese newspapers are reporting Japan’s government has found Intel in violation of the country’s antitrust laws.
* * *
Yomiuri Shimbun reported that the agency found Intel offered discounts on is microprocessors to computer makers in Japan provided they agreed to limit purchases of chips from competing manufacturers.
(c) On 3/8/05, it was reported that the Japan Fair Trade Commission (“JFTC”)
had ordered Intel to cease and desist conduct which violated Section 3 of the Antimonopoly Act
(Private Monopolization). According to the JFTC, since 5/02, Intel had paid the five major
Japanese computer OEMs rebates and/or certain funds referred to as “MDF” (Market
Development Funds) on the condition that the Japanese OEMs purchase 100% of their
microprocessors from Intel and refrain from adopting competitors’ microprocessors. From
these reports, it appeared that Intel did not contest the charges of the JFTC and that Intel’s illegal
kickback payments to its customers in Japan would cease.
118. As Dell was known to purchase 100% of its microprocessor/chip requirements
from Intel, Dell’s stock fell from $40.93 on 3/4/05 to $38.02 by 3/18/05, a decline of over $7
billion in market capitalization, which damaged prior Class Period purchasers of Dell’s stock,
who purchased at higher, inflated prices.
119. Dell’s F05 10-K was filed with the SEC on or about 3/8/05. It was signed by M.
Dell, Carty, Miles, Rollins and Schneider, and contained Dell’s F05 financial results and
statements as audited and certified by PWC. The 10-K stated:
- 113 -
Manufacturing and Materials
Dell manufactures most of the products it sells . . . .
Dell’s manufacturing process consists of assembly . . . functional testing, and quality control. Testing and quality control processes are also applied to components, parts, and subassemblies obtained from third-party suppliers. Quality control is maintained through the testing of components, subassemblies, and systems at various stages in the manufacturing process. Quality control also includes a burn-in period for completed units after assembly, on-going production reliability audits, failure tracking for early identification of production and component problems, and information from Dell’s customers obtained through services and support programs. . . .
. . . Dell currently relies on Intel Corporation as a sole source supplier of processors . . . . These relationships and dependencies have not caused material disruptions in the past, and Dell believes that any disruptions that may occur would not disproportionately disadvantage Dell relative to its competitors.
* * *
The following table summarizes Dell’s consolidated results of operations for each of the past three fiscal years:
Fiscal Year Ended (dollars in millions)
1/28/05 %
Change
1/30/04 %
Change
1/31/03
Net revenue $49,205 19% $41,444 17% $35,404Gross margin $9,015 19% $7,552 19% $6,349% of net revenue 18.3% 18.2% $17.9%Operating expenses $4,761 19% $4,008 14% $3,505% of net revenue 9.7% 9.7% 9.9%Operating income $4,254 20% $3,544 25% $2,844% of net revenue 8.6% 8.6% 8.0%
* * * Net income $3,043 15% $2,645 25% $2,122% of net revenue 6.2% 6.4% 6.0%
* * *
Dell’s superior execution in all product and service offerings has been demonstrated by progress in customer satisfaction ratings during the year, which is a key performance metric for the company.
* * *
- 114 -
Gross Margin
Gross margin as a percentage of net revenue improved slightly to 18.3% during fiscal 2005, compared to 18.2% [in] fiscal 2004 and 17.9% in fiscal 2003. The year-over-year improvement during fiscal 2005 and 2004 was primarily driven by Dell’s continued cost savings initiatives. . . . As part of management’s focus on improving margins, Dell remains committed to reducing . . . manufacturing costs, warranty costs . . . and overhead or operating expenses. These cost savings initiatives also include providing certain customer technical support . . . functions from cost effective locations . . . . Management believes that the strength of Dell’s direct business model . . . makes Dell better positioned than its competitors to continue profitable growth in any business climate.
120. Dell’s F05 10-K also discussed Dell’s accounting policies:
Critical Accounting Policies
Dell prepares its financial statements in conformity with generally accepted accounting practices in the United States of America (“GAAP”). . . . Dell believes its most critical accounting policies relate to revenue recognition, warranty accruals, and income taxes.
* * *
Warranty – Dell records warranty liabilities at the time of sale for the estimated costs that may be incurred under its basic limited warranty. . . . Warranty claims are relatively predictable based on historical experience of failure rates. Each quarter, Dell reevaluates its estimates to assess the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.
121. In or about 4/05, Dell issued its F05 Annual Report. It included a letter from M.
Dell and Rollins which stated:
Our fiscal 2005 was distinguished by best-ever operating results . . . .
Our . . . revenue [and] operating profit . . . were all company records. . . . Operating income rose 20 percent to $4.3 billion, representing 8.6 percent of revenue, our highest rate in four years. . . .
Dell’s exceptional performance again demonstrated the . . . superb execution of a better way of doing business . . . . Our business is a model for customer focus, growth and profitability. We ended the year well ahead of our plan to achieve annual revenue of $60 billion by the end of fiscal 2007. . . .
* * *
And we’re winning the right way, with a high level of integrity . . . .
- 115 -
* * *
Customer Experience
Product leadership helps attract new customers to Dell. But their subsequent experience is critical to returning again and again for their technology needs.
Meeting unique customer requirements is our responsibility and commitment. . . . [T]hose requirements follow simple themes: provide quality products and services, resolve issues when they arise, and show customers how highly they’re valued at Dell. For each of those areas, we persistently track and act in response to how customers say we’re performing against a variety of specific standards.
122. Elsewhere, the F05 Annual Report stated:
Dell is studied by customers worldwide for its expertise in manufacturing. . . .
* * *
Process improvements benefit Dell and customers through lower costs, better quality and better overall customer experience.
123. The F05 Annual Report contained Dell’s recent financial results:
Operating Results (in millions, except per share data)
Fiscal-Year Ended 1/28/05 1/30/04 1/31/03 2/1/02 2/2/01 Net revenue $49,205 $41,444 $35,404 $31,168 $31,888Gross Margin $9,015 $7,552 $6,349 $5,507 $6,443
* * * GAAP operating income
$4,254 $3,544 $2,844 $1,789 $2,663
Pro-forma net income $3,323 $2,645 $2,122 $1,780 $2,310GAAP net income $3,043 $2,645 $2,122 $1,246 $2,177
* * * GAAP earnings per common share
$1.18 $1.01 $0.80 $0.46 $0.79
Percent of Net Revenue Fiscal-Year Ended
1/28/05 1/30/04 1/31/03 2/1/02 2/2/01
* * * GAAP Operating Income
8.6% 8.6% 8.0% 5.8% 8.4%
- 116 -
124. On 4/7/05, Dell held its annual Analyst/Investor Meeting, during which the
following occurred:
[Rollins – CEO:] . . . [T]he model is performing well, the model is solid . . . [and] will continue to be very successful.
* * *
[Schneider – CFO:] . . . I’m always really proud to be able to talk to you about our financial aspects of the business because it’s been such a great story for us. . . . [R]ight now, we’re probably better positioned, financially than we certainly have been in any other point in time in this company’s life.
125. On 4/7/05, Bear Stearns issued a report on Dell based on the analyst meeting,
reporting what had been said there:
Dell Inc. – Outperform . . . Confident About Growth Prospects; Maintaining Estimates And Outperform Rating
* * *
Dell was confident about its prospects to drive growth during its analyst day . . . .
* * *
Key Takeaways from Analyst Meeting:
• . . . [C]onfident about growth prospects. . . . CEO Rollins came across confident about Dell’s ability to drive growth . . . .
• Dell’s Model thrives in a slow-growth environment. Though CEO Rollins signaled a more cautious environment, he noted that Dell’s growth tends to be faster in periods of slower market growth given its low-cost, share gain model.
126. On 5/12/05, Dell reported very strong and record 1stQ F06 results via a press
release stating:
Dell continued to grow significantly faster than the rest of the industry in all global regions, customer segments and product categories during its fiscal first-quarter 2006, and did so with strong profitability.
* * *
- 117 -
For the quarter ended April 29, the company achieved total revenue of $13.4 billion, a 16-percent increase year-over-year, and net earnings of 37 cents per share, up 32 percent and a company record.
1stQ
(in millions, except share data): FY ‘06 FY ‘05 Change Revenue $13,386 $11,540 16% Operating Income $1,174 $966 22% Net Income $934 $731 28% EPS $.37 $.28 32%
127. On 5/12/05, Dell held a conference call for analysts, money managers and
institutional investors concerning its 1stQ F06 results and its business. During the call, the
following occurred:
[Schneider – CFO:] Once again we grew profitably . . . . Our results reaffirm the strength of the model . . . allowing us to continue to outperform the industry.
. . . [W]e delivered EPS of $0.37, an increase of 32% year-over-year on $13.4 billion in revenue. Our operating profit grew 22% year-over-year to $1.2 billion. Operating margin was 8.8%, up 40 basis points year-over-year . . . .
* * *
[Rollins – CEO:] This environment is ideal for our model and plays to the strength of our strategy.
* * *
Dell’s model continues to deliver the exceptional . . . operating results in any environment.
128. On 5/12/05, Bear Stearns issued a report on Dell based on the recent conference
call. It stated:
Dell again stood a cut above the rest, delivering in-line results with robust growth . . . . We’re raising our ests . . . .
* * *
• Gross Margin Above Expectations. Gross margin of 18.61% was above our forecast of 18.46%, up 7 basis points sequentially and 65 basis points from the year-ago period . . . .
* * *
- 118 -
• For FY06, we are raising our EPS estimate from $1.55 to $1.60 . . . .
• For FY07, we are raising our EPS estimate from $1.80 to $1.90 . . . .
129. On 5/13/05, Bloomberg reported:
Shares of Dell Inc., the world’s largest maker of personal computers, rose 4.5 percent after the company said first-quarter profit increased 28 percent . . . .
* * *
[Dell expanded] its first-quarter profit margin to 8.8 percent from 8.4 percent . . . .
* * *
Dell’s shares advanced $1.65 to $38.26 at 10:06 a.m. . . .
Rollins, who took over as CEO from company founder Michael Dell last July, told reporters on a call yesterday he’s “confident and optimistic” and Dell is seeing “healthy” demand . . . .
130. On 5/13/05, PacificCrest issued a report on Dell based on the recent conference
call which stated:
Renewed Confidence in Profitable Growth Prompts Upgrade
* * *
The gross margin improved to 18.6% from less than 18% in the prior year; it reached the highest level in four years.
. . . We are upgrading Dell . . . .
* * *
The most surprising element of the quarter was the upside in the gross margin, [due to] declines in component costs.
131. On 5/13/05, Deutsche Bank issued a report on Dell based on the recent conference
call. It stated:
Gross margins of 18.6% were 10bps above our estimates. . . . Essentially, we believe Dell enjoyed better margins in Consumer due the favorable component environment. . . . EPS was $0.37 in the quarter . . . .
- 119 -
132. On 6/3/05, Dell filed its 1stQ F06 report on Form 10-Q with the SEC, signed by
Joan S. Hooper (“Hooper”), Dell’s CAO. It contained the same financial results earlier reported
and stated:
[W]e delivered strong operating results and strengthened our financial position.
* * *
Three Months Ended
4/29/05 4/30/04
Dollars % of
Revenue Dollars
% of Revenue
% Change
(in millions, except per share amounts and percentages)
Revenue $13,386 100.0% $11,540 100.0% 16% Gross Margin 2,491 18.6% 2,073 18.0% 20% Operating expenses 1,317 9.8% 1,107 9.6% 19% Operating income 1,174 8.8% 966 8.4% 22% Net income 934 7.0% 731 6.3% 28% Earnings per share – diluted
0.37 N/A 0.28 N/A 32%
* * *
Dell’s gross margin as a percentage of revenue increased to 18.6% during the first quarter of fiscal 2006, compared to 18.0% during the first quarter of fiscal 2005. Our year-over-year improvement in gross margin is due to favorable pricing on certain commodity components . . . . The strength of our direct-to-customer business model . . . position[s] us to pursue share gains in any business climate. As part of our focus on improving margins, we remain committed to reducing . . . manufacturing costs [and] warranty costs . . . . Cost savings initiatives include providing certain customer technical support . . . from cost-effective locations . . . .
133. The statements made between 3/05 and 6/05, as pleaded above, included:
• Dell was reporting “strong profitability” and “record” results – which were being achieved with a “high level of integrity,” leaving Dell “better positioned financially than in any other point in time.”
• Dell’s model was “solid” and “performing well,” with “superior execution in all product and service offerings,” resulting in “exceptional operating results in any environment,” “demonstrated by progress in customer satisfaction – a key performance metric for the company.”
- 120 -
• “The strength of [Dell’s] direct business model makes Dell better positioned than its competitors to continue profitable growth in any business climate” and Dell “will continue to be very successful.”
• Dell’s top officers had reviewed Dell’s internal financial and accounting and disclosure controls. Those controls were effective to assure accurate preparation of Dell’s SEC filings and that no undisclosed deficiencies in Dell’s internal controls or fraud – material or otherwise – existed at Dell.
These statements impacted and were reflected in the market trading price of Dell stock. The
statements set forth in ¶¶119-133 were false and misleading. The true undisclosed facts, which
were known to or recklessly disregarded by each of the Dell Defendants, were:
(a) The Dell Direct business model was not operating successfully or creating
the strong, often record, financial results and operating margins Dell was reporting; in fact, due
to overly aggressive cost-cutting in Dell’s customer support and service and manufacturing
operations, Dell’s business model was being afflicted with sky-rocketing customer
dissatisfaction and complaints, as well as increasing product quality problems (especially with
laptop batteries and capacitors). In truth, Dell’s financial results were being falsified and
temporarily inflated by (i) large cost-cuts which would have to be reversed and remediated; (ii)
improper accounting tricks, including under-accruing warranty costs and failing to take timely
write-downs for defective products and product replacement; and (iii) its secret receipt of some
$200 million per quarter in rebate/kickback payments from Intel in return for exclusively
purchasing Intel microprocessors/chips.
(b) Dell was not manufacturing or selling the highest quality products, as
Dell’s aggressive cost-cutting in its manufacturing operations to boost its reported profits in the
short term had badly weakened Dell’s quality control procedures and standards for component
parts, i.e., batteries and finished goods, such that Dell was encountering an upsurge in customer
complaints due to faulty products, including capacitor failures, motherboard failures and
widespread laptop (lithium) battery defects.
- 121 -
(c) Dell did not have an unrivaled ability to create products or technologies
that met or exceeded customer expectations, nor did it have world-class manufacturing
excellence, producing high-quality products. In fact, as a result of the aggressive cost cuts in
Dell’s manufacturing operations, Dell’s quality assurance procedures had become badly
impaired, leading to a marked decline in product quality.
(d) Dell’s cost-cutting program was resulting in a marked increase in the
production of defective products which did not meet Dell’s historic quality standards and a
marked decline in Dell’s historic levels of customer support and service and thus customer
satisfaction, which Dell insiders knew would cost hundreds of millions, if not billions, of dollars
to remedy, including the hiring of thousands of additional full-time employees to be trained to
staff customer call centers and to improve Dell’s quality assurance techniques and practices in its
manufacturing operations.
(e) In order to cut operating costs, Dell had sharply curtailed its quality
control processes by no longer testing component parts (specifically batteries, hard drives,
optical drives or motherboards and laptop accessory parts, including power adaptors) received
from suppliers. Rather, Dell was relying on post-assembly quick tests of completed units to
discover defective component parts. In addition, it had also curtailed the post-assembly “burn-
in” testing of units, which steps in combination were resulting in Dell shipping much larger
numbers of computers with defects and performance problems, leading to increased quality
problems and customer dissatisfaction.
(f) Dell was not providing superior customer service and support as, due to
overly aggressive cost-cutting activities in Dell’s customer support and service operations to
boost its reported profits in the short term, including moving most of Dell’s consumer and small
business customer support and service call centers to India and the Philippines and replacing full-
- 122 -
time, well-trained employees with part-time, ill-trained (but cheaper) employees, Dell’s customer
support and service operations were badly impaired, resulting in very long wait times and an
inability to adequately respond to customer complaints and questions, generating an upsurge in
customer anger and dissatisfaction with Dell, its products and its customer support and service
which Dell’s internal metrics showed would hurt sales.
(g) Because of its shifting of much of its customer support and service
operations, especially for its consumer and small business customers, to “call centers” in India
and the Philippines and staffing its call centers with part-time, poorly trained employees, Dell
was no longer providing a superior customer experience or generating high degrees of (or
improving) customer satisfaction. Rather, Dell was encountering a widespread customer revolt
with a massive upsurge in complaints regarding declining product quality and declining service
and support operations and a sharp decline in one of Dell’s key internal metrics – the “likely to
repurchase” number.
(h) The Dell Direct model also was not functioning effectively with respect to
Dell’s direct sales process because Dell had flooded the market with a huge number of confusing
and contradictory promotional offers which its now ill-trained and inadequate sales force was
unable to effectively process. This was leading to refusals to honor many “coupons” and
“promotions,” resulting in customer dissatisfaction and refusal to buy Dell products, which was
showing up in an important internal Dell metric known as the “likely to repurchase” number,
where Dell was seeing soaring negative sentiment which meant customers were displeased with
the Dell sales process and thus Dell’s sales growth would decline.
(i) While Dell publicly disseminated favorable surveys and reports purporting
to show a high degree of Dell customer satisfaction with product quality and service and support,
in fact, its own internal surveys, information and customer metrics (which it constantly
- 123 -
monitored) showed a huge upsurge in customer dissatisfaction with and anger at Dell, including
a measurable increase in negative responses to its most important metric, the so-called “likely to
repurchase” number, which Dell knew indicated serious problems with ongoing sales growth.
(j) Dell’s increasing product quality was not resulting in a decrease in Dell’s
warranty costs. In fact, Dell had quietly curtailed the length of its product warranty and sharply
curtailed the breadth of its warranty coverage (it had eliminated the computer operating system
from its warranty) and, in addition, had secretly adopted a new “fix-on-fail-only” policy,
whereby it would provide in-home repair service or product replacement only when a computer
(or component) completely failed, as opposed to merely malfunctioned, to cut costs. However,
these severe restrictions in Dell’s warranty and service to its customers – which was much
different than Dell’s historic “customer friendly” approach to warranty, service and product
quality issues – were causing an upsurge in customer dissatisfaction with and anger at Dell,
which Dell insiders knew would inevitably result in declining sales growth and a massive
increase in warranty and product repair costs to try to restore customers’ satisfaction to
acceptable levels.
(k) Dell’s F05 and 1stQ F06 financial results and statements were artificially
inflated and falsified, as detailed in ¶¶233-273, due to a failure to properly accrue required
amounts for warranty costs, failure to recognize material product defect/recall costs and failure to
properly disclose the existence, nature and extent of the huge rebate payments Dell was receiving
each quarter from Intel.
(l) Dell’s Sarbanes-Oxley representations were false, as Dell’s internal
financial and accounting and disclosure controls were deficient and an undisclosed material fraud
was ongoing at Dell – Dell’s financial statements were being falsified, its disclosures in its SEC
- 124 -
filings were false and misleading and an ongoing fraudulent violation of the securities laws was
occurring.
(m) Dell’s statements regarding its ability to quickly benefit financially from
declines in component part prices was false and misleading. The true reason for Dell’s reported
superior operating margins was, in large part, the hundreds of millions of dollars of secret and
likely illegal rebate/kickback payments Dell was receiving from Intel at the end of each quarter
in return for purchasing 100% or virtually 100% of its microprocessor requirements from Intel.
(n) Due to customer demand for PCs with the advanced features and
advantages of the new AMD microprocessor chips, Dell had decided it would have to begin to
purchase AMD chips for its computers, which would mean the loss of those hundreds of millions
of dollars of rebate/kickback payments from Intel, which would hurt Dell’s operating profits and
margins.
(o) Dell’s U.S. consumer/small business operations were not “going
gangbusters,” or achieving success, but, in fact, were performing very poorly and well below
expectations due, in large part, to the product quality and customer service and support
deficiencies outlined above.
(p) The Dell Direct business model was not advantaged in all environments
across all regions and in all product categories or able to cause Dell to report solid profits and
rapid growth regardless of prevailing market conditions due to product quality and customer
service and support issues due to the deficiencies and defects detailed above.
(q) The Dell Direct model did not tend to strengthen in slower growth
environments or thrive even in periods of slower component price declines or show strength
when demand slowed because of the product quality and customer service and support
deficiencies outlined above.
- 125 -
(r) Dell’s purported improvements in reducing its operating expenses as a
percentage of net revenues and the reported increases in its net and gross operating profit
margins to record high levels were only being achieved at the cost of the serious product quality
and customer support and service problems outlined above and which the Dell Defendants knew
would require massive expenditures to fix, harming Dell’s profitability going forward.
(s) Due to the material adverse facts and problems set forth above, Dell and
the Dell Defendants knew that Dell could not and would not achieve the revenue, operating
profit, operating profit margins, net income and EPS growth being forecast by them.
134. On 6/6/05, Bear Stearns reported on a dinner with Dell CEO Rollins, repeating
what he had said:
Dell Inc. – Outperform Upbeat About Growth Prospects In Good Times And Bad;
Maintaining Estimates And Outperform Rating
* * *
We hosted a dinner with Dell CEO Kevin Rollins on the eve of Bear Stearns 16th Annual Tech Conference . . . . Rollins highlighted Dell’s growth capabilities in all markets, indicating its advantages tend to strengthen in slower growth environments . . . .
* * *
Rollins noted that he almost cheers when demand slows as Dell’s strengths become accentuated . . . .
135. On Friday, 6/17/05, Dell traded as high as $41.22. On Tuesday, 6/21/05, the
following complaint about Dell was posted on a Blog called BuzzMachine by one Jeff Jarvis:
Dell lies, Dell sucks.
Dell lies. Dell sucks.
I just got a new Dell laptop and paid a fortune for the four-year, in-home service. The machine is a lemon and the services is a lie. I’m having all kinds of trouble with the hardware: overheats, network doesn’t work, maxes out on CPU usage. It’s a lemon. But what really irks me is that they say if they sent someone to my home – which I paid for – he wouldn’t have the parts, so I might as well just send
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the machine in and lose it for 7-10 days – plus the time going through this crap. So I have this new machine and paid for them to FUCKING FIX IT IN MY HOUSE and they don’t and I lose it for two weeks. DELL SUCKS. DELL LIES. Put that in your Google and smoke it, Dell.
The 6/21/05, anti-Dell Blog on BuzzMachine attracted worldwide attention – and support.
136. On 6/28/05, AMD issued a release describing a suit it had filed against Intel,
alleging antitrust violations, including secret illegal rebates/kickbacks to Dell:
AMD Files Antitrust Complaint Against Intel In U.S. Federal District Court
* * *
This litigation follows a recent ruling from the Fair Trade Commission of Japan (JFTC), which found that Intel abused its monopoly power to exclude fair and open competition, violating Section 3 of Japan’s Antimonopoly Act. These findings reveal that Intel deliberately engaged in illegal business practices to stop AMDs increasing market share by imposing limitations on Japanese PC manufacturers. Intel did not contest these charges.
The European Commission has stated that it is pursuing an investigation against Intel for similar possible antitrust violations and is cooperating with the Japanese authorities.
Among the violations alleged in AMD’s suit were that Intel:
• Forc[ed] major customers such as Dell . . . into Intel-exclusive deals in return for outright cash payments, discriminatory pricing or marketing subsidies conditioned on the exclusion of AMD . . . . [A]s confirmed by the JFTC in Japan, Intel has paid Dell . . . huge sums not to do business with AMD.
137. AMD’s actual complaint against Intel alleged:
Exclusionary Rebates
Intel has also imposed on OEMs a system of first-dollar rebates that have the practical and intended effect of creating exclusive or near-exclusive dealing arrangements and artificially foreclosing AMD from competing for a meaningful share of the market. In general, the rebate schemes operate as follows: quarterly, Intel unilaterally establishes for each of its customers a target level of purchases of Intel microprocessors. If the customer achieves the target, it is entitled to a rebate on all of the quarter’s purchases of all microprocessors – back to the very first one – generally in the neighborhood of 8-10% of the price paid. Intel provides the rebate in cash at the quarter’s close. OEMs operate on razor-thin margins, so qualifying for an Intel rebate frequently means the
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difference between reporting a profit or a loss in the coming – and closely watched – quarterly earnings.
138. On 8/11/05, after the close of trading, Dell shocked the markets with much lower-
than-expected 2ndQ F06 results, including revenues. Dell also revealed that its 3rdQ F06
revenue growth would also fall short of its prior forecasts. On 8/12/05, Investor’s Business Daily
reported:
Dell Takes Hit After Its Sales Lag Estimates; Forecast Also Disappointing
Investors dumped shares of Dell Thursday after the computer maker reported quarterly sales below what analysts had expected. It also guided sales forecasts down for the current quarter.
* * *
The sales shortfall came as a shock to Wall Street . . .
“It was definitely a surprise to the Street,” said Shaw Wu, an analyst with American Technology Research.
139. On 8/12/05, Bloomberg reported:
Shares of Dell Inc. fell 7.4 percent, the most in four years, on signs the revenue surge that transformed the company into the world’s largest maker of personal computers is subsiding.
Analysts responded to Dell’s report that sales growth fell to the lowest in three years by slicing their recommendations and estimates. Goldman, Sachs & Co.’s Laura Conigliaro, whose firm took Dell public in 1988, reduced her rating on the stock. Merrill Lynch & Co.’s Steve Milunovich, ranked the No. 2 computer analyst by Institutional Investor magazine, reduced his estimates.
140. Dell’s stock plunged from $40.03 on 8/11/05 to $36.10 on 8/12/05 on huge
volume of 96.2 million shares, as the 8/11/05 revelations were inconsistent with and undercut
prior Class Period representations. This approximate $10 billion loss of market capitalization in
Dell’s stock took some of the artificial inflation out of Dell’s stock, damaging prior Class Period
purchases.
141. While Dell’s stock fell sharply after the negative results of 8/11/05, it continued to
trade at artificially inflated levels, as defendants failed to make full or complete disclosure and
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continued to make false and misleading statements concerning Dell’s business, its business
model and its finances and financial condition and results, assuring investors that the problems
contributing to the financial shortfall had been identified and fixed. For instance, on 8/11/05,
Dell held a conference call for analysts, money managers and institutional investors. During this
call the following occurred:
[Schneider – CFO:] Dell continued to outperform the market in our second quarter. We posted record earnings . . . . [W]e generated $13.4 billion in revenue . . . . This was below the guidance we gave at the beginning of the quarter. . . . While we’re short on revenue we focused on delivering our earnings commitment. Our operating profit grew 17% year-over-year to $1.2 billion, delivering operating margin of 8.7%, an improvement of 10 basis points year-over-year. . . . We generated pro forma EPS of $0.38, up 23% and in line with our guidance.
* * *
[Runkle – Morgan Stanley – Analyst:] . . . [J]ust in terms of your commentary about misexecuting, as you go back and look at how or why you misexecuted, how are you thinking about that issue . . . .
[Rollins – Dell, Inc. – CEO:] . . . First off, our earnings came in exactly as expected, and the growth rate in terms of units exceeded expectation. The shortfall was in the revenue, and I think the issue for us is that . . . we just misexecuted and didn’t get the up sell within the consumer business that we normally got and let it get away from us. That’s the misexecution that we think we can fix. We know how to do it, we’ve been doing it now for ten years. We stumbled there, but we’ll get it back in line.
* * *
[W]e’re not changing our strategy. . . . [W]e’ll continue to drive balanced, profitable growth in Q3 and beyond. . . . [W]e believe there’s multiple engines of growth for our company . . . . We’re confident in our ability to deliver on those commitments . . . .
142. On 8/17/05, Prudential issued a report on Dell based on a lunch with Schneider,
Dell’s CFO, reporting what he told Prudential:
• Yesterday afternoon, we hosted a lunch with Jim Schneider, Dell’s CFO.
• We left the meeting confident that management has identified and addressed the problem areas which drove the FQ2 revenue shortfall . . . .
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143. An 8/17/05, Jeff Jarvis “Blogged” an open letter to Dell on “BuzzMachine.” The
letter stated:
To: Michael Dell . . . .
CC: Michael George, chief marketing officer and vice president for the U.S. consumer business, Dell
Gentlemen:
Your customer satisfaction is plummeting, your marketshare is shrinking, and your stock price is deflating.
Let me give you some indication of why, from one consumer’s perspective. I won’t bore you with all the details of my saga of Dell hell; you can read all about it here and here. The bottom line is that a low-price coupon may have gotten me to buy a Dell, but your product was a lemon and your customer service was appalling.
. . . I’m typing this on an Apple Powerbook. I also have bought two more Apples for our home.
But you didn’t just lose three PC sales and me as a customer.
Today, when you lose a customer, you don’t lose just that customer, you risk losing that customer’s friends. And thanks to the internet and blogs and consumer rate-and-review services, your customers have lots and lots of friends all around the world.
I blog. And I shared the story of my Dell travails here. The topic resonated with hundreds more people. Go read the many comments here and here. Too busy? Then have an intern or an MBA do it for you.
And then have them read all the many posts of other bloggers who pointed to my posts and shared their dissatisfaction with your products, service, and brand and, in many cases, announced that they were no longer going to buy your name: See some of those posts here or here and you’ll learn a lot.
Heard of those new podcast things? Well, you’re in one.
Now go read the press this generated, because the press is reading blogs, even if you’re not: here (where Fast company turned customer dissatisfaction into a verb: you got Dell’d), here (ZDnet not just in America but in India, where your many customer-service people are probably reading this, even if you’re not), here (a mainstream newspaper), here (an influential online news service), here (a consumer PC magazine), here (BusinessWeek, guys), and plenty more here: Just Google it; you should be doing that every day.
* * *
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So allow me to give you some friendly and free advice about these blog things. You can pay for more.
Read blogs. Go to Technorati, Icerocket, Google, Bloglines, Pubsub, and search for Dell and read what they’re saying about you. Get it out of your head that these are “bloggers,” just strange beasts blathering. These are consumers, your marketplace, your customers – if you’re lucky. They are just people. You surely spend a fortune on consumer research, on surveys and focus groups and thinktanks to find out what people are thinking. On blogs, they will tell you for free. All you have to do is read them. All you have to do is listen.
* * *
Listen to all your bad press and bad blog PR and consumer dissatisfaction and falling stock price and to the failure of your low-price strategy and use that blog to admit that you have a problem. Then show us how you are going to improve quality and let us help. Make better computers and hire customer service people who serve customers.
* * *
Sincerely,
Jeff Jarvis
144. On 8/17/05, The Philadelphia Inquirer published an article regarding Dell’s
declining customer satisfaction:
Dell rated lowest in recent index of client satisfaction; PC buyers cited long waits, unanswered questions. . . .
Dell Inc.’s customer satisfaction fell this year to the lowest rating since 1998 as consumers complained of long wait times for help and trouble getting questions answered.
Customer satisfaction at Dell . . . declined 6.3 percent, as gauged by the University of Michigan’s American Customer Satisfaction Index.
Dell’s decline may be a sign the company is poised to lose sales, said Claes Fornell, marketing professor and head of the university’s National Quality Research Center. . . .
“Dell is dropping in large part because of call-center problems, including long wait times and difficulty with consumers’ getting their questions answered,” Fornell said in an interview. “Consumers are also questioning the reliability of their PCs.”
* * *
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“The satisfaction of customers is pretty much a leading indicator as to whether customers will come back and buy more,” Fornell said. . . .
Dell chairman Michael Dell told analysts last week that internal surveys showed customer satisfaction “improved” in the last quarter, even as PC shipments rose and the number of consumers being served increased.
145. According to the Austin American-Statesman, Rollins refuted the findings. “CEO
Kevin Rollins disputed the analysis last week, telling reporters and later analysts that, rather than
slipping, the company’s performance was improving. A recent ranking from Technology
Business Research put Dell No. 1 in customer service for business customers. And the
company’s own scores for its consumer service have risen ‘over the last quarter or so,’ Rollins
said. ‘Our unit volumes are large,’ he said. ‘So you could actually get more calls, but the
percent of calls is going down.’”
146. On 8/25/05, BusinessWeek Online published an article that was negative
concerning Dell’s customer satisfaction, noting the widespread attention given the 8/17/05
BuzzMachine blog activities:
Dell: In the Bloghouse; A PC-owner’s Web diary of complaints about customer service has yielded heavy traffic and some near-contrition from the maker
PC industry circles have been buzzing in recent months that Dell’s (DELL) customer support is slipping – a claim bolstered on Aug. 16 by a University of Michigan study that showed a hefty decline in customer satisfaction from a year ago. So the last thing Dell needed was for someone to turn the customer-service issue into a cause celebre.
Enter Jeff Jarvis.
Over the summer, Jarvis began writing in his personal blog, BuzzMachine, about his lengthy quest to fix a $1,600 computer, an ordeal he said included countless e-mails, some unanswered, and phone calls to Dell’s customer-service line.
“A LEMON.” Jarvis wrote in his blog that he bought a service package including in-home repairs, but when the PC overheated and malfunctioned, he was told to send it in.
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It still wasn’t working when it came back, however, according to Jarvis. So he launched a series of attacks on Dell, including an Aug. 17 open letter to CEO Michael Dell saying: “The bottom line is that a low-price coupon may have gotten me to buy a Dell, but your product was a lemon, and your customer service was appalling.”
* * *
John Hamlin, Dell’s senior-vice president for the U.S. consumer business, says Dell is adding more call centers, each employing about 2,000 workers, and improving training for phone reps.
“The customer experience is one of the most important issues for us,” says Hamlin, adding that a year ago, to make sure customers’ machines are working, Dell began contacting those who its records show have sought help at least three times over the course of one week.
147. On 8/25/05, BusinessWeek Online published a second article – this one about
Dell’s slowing growth:
What’s With the Dell Doldrums?
* * *
[W]hy are Dell shares down 16% since the end of last year . . . .
* * *
[T]he sales number was below its own earlier forecast of a 16% to 18% increase. Worse yet, Dell also ratcheted down its revenue projections for the current quarter ending in October. Dell’s stock immediately tanked 7.4%.
INVESTORS’ “WHIPSAW.” Some analysts are questioning whether Dell stock still deserves its longstanding rating. On Aug. 12, high profile Goldman Sachs analyst Laura Conigliaro downgraded Dell to “market perform” from “Outperform” because of the lower estimate for future sales growth.
148. This negative publicity concerning Dell was furthered when, on 8/30/05,
Moneybox published an article regarding Dell, headlined and stating:
Is Dell Dying?
* * *
[A]ll of a sudden, Dell is getting walloped. There has been a disappointing earnings report, complaints about customer service, unflattering stock charts, and a rash of articles questioning Dell’s future – Business Week had two
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negative Dell articles in its current issue, and the Financial Times had a critical takeout last week.
Dell’s disappointing quarter was the proximate cause of the negative press. . . . [I]t represented the first time in several years that Dell failed to meet the earnings estimates. What’s more, executives ratcheted down expectations for revenue growth in the current quarter. The stock has fallen 11 percent since the announcement.
* * *
Dell had the bad luck to tick off a very powerful blogger. . . . It was Dell’s misfortune that one of those errors affected a person with a huge megaphone, blogger Jeff Jarvis. Jarvis’ blow-by-blow account of his Dell hell has become an Internet phenomenon.
149. Dell’s stock fell during the second half of 8/05, as this negative information,
which undermined and contradicted Dell’s earlier and ongoing representations, reached and was
digested by the market. Dell’s stock fell from $37.05 on 8/18/05 to $35.05 on 8/29/05, a $5
billion loss of market capitalization, damaging prior Class Period purchasers.
150. On 9/1/05, Dell filed its 2ndQ F06 report on Form 10-Q with the SEC, signed by
Hooper. The 2ndQ F06 10-Q contained Dell’s earlier reported financial results. It also stated:
Second Quarter Performance Highlights
* * *
Operating Income Operating income increased 17% to $1.2 billion for the quarter, or 8.7% of revenue, up from $1.0 billion and 8.6% of revenue in the second quarter of fiscal 2005.
Earnings Earnings per share increased 32% to $0.41 for the quarter.
* * *
Results of Operations
The following table summarizes the results of our operations for the three and six month periods ended July 29, 2005 and July 30, 2004:
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Three Months Ended Six Month Ended July 29, 2005 July 30, 2004 July 29, 2005 July 30, 2004
Dollars % of
Revenue Dollars
% of Revenue
Dollars
% of Revenue
Dollars
% of Revenue
(in millions, except per share amounts and percentages) Revenue $13,428 100.0% $11,706 100.0 % $26,814 100.0% $23,246 100.0% Gross margin 2,499 18.6% 2,134 18.2% 4,990 18.6% 4,207 18.1% Operating expenses
1,326 9.9% 1,128 9.6% 2,643 9.9% 2,235 9.6%
Operating income
1,173 8.7% 1,006 8.6% 2,347 8.8% 1,972 8.5%
Net income 1,020 7.6% 799 6.8% 1,954 7.3% 1,530 6.6% Earnings per share-diluted
$0.41 N/A $0.31 N/A $0.78 N/A $0.59 N/A
* * *
[O]ur gross margin as a percentage of revenue increased to 18.6% for both the second quarter and first six months of fiscal 2006, compared to 18.2% and 18.1% for the same period in fiscal 2005, respectively. . . . As part of our focus on improving margins, we remain committed to reducing costs . . . . Cost savings initiatives include providing certain customer technical support . . . .
151. Dell’s 2ndQ F06 10-Q also contained the Sarbanes-Oxley certifications signed by
Schneider and Rollins, detailed at ¶¶269-273.
152. The positive statements made by defendants regarding Dell during 6/05-9/1/05
artificially inflated Dell’s stock, which traded as high as $41.99 on 7/20/05. As Dell’s stock
traded at these artificially inflated levels, Dell’s top executives’ stock options remained “in the
money,” Dell insiders unloaded more of their stock to profit from their “pump-and-dump”
scheme. Between 2/15/05 and 9/7/05, they sold off 3.5 million shares of their Dell stock for
$139 million in illegal insider trading proceeds.
153. During 9/05, a further series of negative company-specific revelations concerning
Dell occurred in a series of articles and analyst reports that contained and disseminated
information that continued to undercut and contradict defendants’ prior positive representations:
(a) On 9/3/05, the New York Times published a negative article about Dell:
Is Dell a Buy For Consumers Or Investors?
* * *
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Dell’s ability to maintain margins through strong customer service seems to be slipping. In the University of Michigan’s latest customer-satisfaction survey, Dell’s lead over the rest of the industry – except Apple, which is adored by its small but fiercely loyal base of owners – has evaporated.
Another survey gave the company even lower marks. The sample size was small, however – one person, me – so pedantic, old-school pollsters may question its validity.
I ordered a Dell PC, but when I called back with questions, the transaction could not be found under my name, phone number or ZIP code. Apparently, the order taker hit the trifecta and got them all wrong.
When I expressed my frustration, the rep hung up. I called back, seething, to cancel the purchase, but there was no need. The order taker had also entered my card details incorrectly, so it was never processed.
Jennifer Davis, a Dell spokeswoman, conceded service problems exist at the company . . . .
(b) On 9/5/05, Business Week reported:
DELL FINDS ITSELF IN BLOG HELL
PC industry circles have been buzzing for months about slipping customer support at Dell, a claim bolstered on Aug. 16 by a University of Michigan study that showed a hefty drop in customer satisfaction from a year ago. So the last thing Dell needed was for someone to turn the issue into a cause celebre.
Enter Jeff Jarvis. Over the summer the media critic and popular blogger began writing on his personal blog, BuzzMachine, about his lengthy quest to fix a $1,600 computer, an ordeal that, according to him, included countless e-mails, some unanswered, and phone calls to Dell’s service line. Jarvis wrote that he bought a service package that included in-home repairs, but when the PC overheated and malfunctioned, he was told to send it in. He did – and wrote that it still wasn’t working upon return. Jarvis launched a series of attacks, including an Aug. 17 open letter to CEO Michael Dell: “The bottom line is that a low-price coupon may have gotten me to buy a Dell, but your product was a lemon, and your customer service was appalling.” On Aug. 22, Jarvis finally got a refund. A day later he blogged that Dell’s new policy of tracking down unhappy bloggers “is a start.”
Jarvis’ rants struck a chord with other Dell customers. Daily visits to BuzzMachine have doubled, to over 10,000 estimates research firm Intelliseek. . . .
(c) On 9/11/05, The Sunday Times published a negative article regarding Dell
headlined and stating:
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Once-mighty Dell is no longer a world beater
* * *
After years of adulation, Dell faces the kind of criticism usually leveled at its rivals.
* * *
Dell is getting walloped. Once-friendly analysts have doubts about the company’s future growth, and its share price is down.
(d) On 9/12/05, Barron’s published a negative article about Dell stating:
[N]ot everyone feels good about Dell these days, including, most notably, its stockholders.
Investor angst became especially evident last month when Dell reported its second-quarter results for the fiscal year ending January. . . . [S]ales came in 2% below the company’s guidance, at $13.4 billion for the three months. However tiny, that shortfall was disappointing enough to investors that they slammed the shares down nearly 10% overnight, to $36.64, cutting nearly $10 billion off Dell’s market value.
. . . “Confidence in the company’s ability to perform has seriously shaken the market sentiments,” says Niral Dalal, an analyst with research house First Global.
(e) On 9/12/05, B to B published a negative article about Dell’s poor customer
satisfaction:
How one man’s Weblog became Dell’s nightmare
What’s worse than an unsatisfied customer? How about an unsatisfied customer who is one of the most popular bloggers on the Web?
That’s exactly what happened to Dell Computer this summer. What began as a personal account by former mainstream journalist Jeff Jarvis of his problems with Dell on his BuzzMachine blog has turned into a public perception nightmare for the Austin, Texas-based computer company.
Jarvis, a media veteran . . . posted his initial ticked-off commentary about Dell in June. He had bought a Dell laptop that malfunctioned, requiring him to send it back even though he had purchased an expensive in-home service agreement. That first rant got 108 reader comments, with many trading personal stories of unsatisfactory service.
As June went on, Jarvis continued to detail his Dell experiences. He got the computer back, but it still overheated. Then the hard drive broke, and still no
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one answered his e-mails. He logged all the activity, giving his write-ups such titles as “Dell Sucks. Dell Lies” and “Dell Hell, Continued.” . . .
. . . The blogging continued to rage, on both Jarvis’ site and others, with Jarvis writing an open letter Aug. 17 to Michael Dell and CMO Michael George lamenting their lack of response as well as offering suggestions on how to interact with bloggers. Mainstream media picked up on the story, including BusinessWeek, Fast Company, ZDNet, PC World and the Houston Chronicle.
(f) On 9/29/05, Moors & Cabot, a boutique research firm, released a negative
report on Dell, focused on Dell’s declining customer support and service and customer
satisfaction:
[W]e think deteriorating service and support ratings could be a drag for two or more years. . . . [W]e believe disappointing sales and support experiences over the last few years . . . have been a negative for Dell. . . .
. . . [T]here have been an increasing number of complaints regarding Dell’s service and support for two to three years. . . .
• University of Michigan American Customer Satisfaction Index (ACSI) – In Aug-05, Dell’s ACSI rating of 74 fell 6.3% Y/Y and was the company’s worst showing since 1998. . . . Customer complaints are up significantly with long wait-times, and difficulties with Dell’s call-center abound. Consumers are also questioning the reliability of their PCs.”
• Consumer Reports – Dell’s Mar-05 desktop tech support score was 62 out of a possible 100, down from 74 in Dec-01 and 65 in Sep-02. . . .
• Technology Business Research – In TBR’s 4Q04 report on support satisfaction among corporate buyers, Dell’s satisfaction rating slipped to 81.0, down from 83.4 in 3Q03. . . . [I]ts score was the lowest since TBR began tracking Dell’s satisfaction levels in 1Q01 and was well below Dell’s average rating of 82.9 in TBR surveys.
(g) On 10/1/05, Direct published an article about Dell’s poor customer
service/satisfaction:
Dell Takes One Hell of a Blogging
Type the phrase “Dell Hell” on Google and the world’s most popular search engine returns more than 2.4 million results. Type “Dell sucks” and almost 1.3 million results come back.
Dude, Dell has a problem.
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The computer marketing giant has taken a serious battering, in large part because of a summer-long rant on a journalist’s personal blog. Jeff Jarvis began writing on BuzzMachine in June about his fruitless efforts to get Dell to fix his malfunctioning computer, a quest he claims included an infuriating string of unanswered or improperly handled e-mails and phone calls.
* * *
In an open letter to Dell, Jarvis wrote: “Your product was a lemon, and your customer service was appalling. . . . Today, when you lose a customer, you don’t lose just that customer, you risk losing that customer’s friends. And thanks to the Internet and blogs and consumer rate-and-review services, your customers have lots and lots of friends all around the world.”
The following day the letter was the third most linked-to post in the blogosphere . . . .
* * *
“Dell has become worse than a door-to-door salesman,” Jarvis wrote. “No pride. No shame. No value. No brand. As I said when all this started: Dell sucks.”
This story is old news in the blogosphere. For Dell, however, its ramifications probably haven’t even begun to emerge.
It’s hard to imagine that any consumer doing the slightest amount of online research for their next computer purchase won’t stumble across the negative comments about Dell.
And the Internet is littered with posts indicating that Jarvis is far from alone.
* * *
The firm is “past the point of no return,” wrote Steve Rubel, vice presidence of client services for public relations firm CooperKatz & Co. of New York, on his blog Micro Persuasion.
(h) On or about 10/3/05, the 10/10/05 edition of BusinessWeek published
another negative article about Dell’s customer service/satisfaction:
Hanging Up On Dell?; Gripes about tech support are on the rise, and the PC king is scrambling to upgrade
It didn’t seem as if he was asking for much. When the CD drive on Peter Ulyatt’s Dell desktop computer failed this summer, he called the support crew at Dell, where he’d bought the $1,600 machine nine months prior. Armed with an extended warranty that cost him an extra $300, the Pasadena (Calif.) retiree got on
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the phone and waited. After sitting on hold for 45 minutes, a technician whom Ulyatt could barely understand came on line and diagnosed a “software problem.” Ulyatt’s call, transferred to the software technician, was dropped. Calling back, Ulyatt waited on hold another 45 minutes, asked for the software desk, and waited a half-hour more before hanging up. “At the moment, I’m not high on Dell’s service,” says Ulyatt, who plans to buy two new PCs in a year or so. “When I buy again, I will look at others beyond Dell.”
Ulyatt’s ordeal is not an isolated case. . . . [R]ecent surveys suggest the ranks of frustrated Dell Inc. owners are growing. Complaints to the Better Business Bureau rose 23% in 2004 from the year before, and they’re up another 5% this year. And Dell’s customer-satisfaction rating fell 6.3%, to a score of 74, in a survey by the University of Michigan. Dell’s score puts it right at the PC industry’s average for the study, in which Apple Computer Inc. led the way with an 81. Still, it’s a big decline, especially for a company that has often topped the list. “We’ve never seen a drop like this,” says professor Claes Fornell, who ran the survey.
Plenty of people are going public with complaints. Media critic Jeff Jarvis has recounted his frustrations on his blog. Web sites such as ihatedell.net have popped up. Helaina Burton recently spent three hours taking to a half-dozen Dell reps – all to solve the simple problem of a faulty keyboard. “I certainly won’t buy another product from Dell,” she says. “I will make sure that any other prospective Dell customer I meet knows what kid of treatment they’ll get.”
Could such sentiment lead to trouble for the world’s largest PC company? Over the past decade, Dell’s dependable support, combined with competitive prices and build-to-order convenience, made it the default choice for millions of consumers. . . . [A] sagging reputation could slow sales . . . . In the most recent quarter, Dell missed its sales target, one reason its stock has dropped 18%, to $34, since the start of the year.
* * *
Dell is working to reverse the service slide. John Hamlin, senior vice-president of Dell’s U.S. consumer business, says the company is hiring a few thousand additional reps this year and striving to reduce call transfers.
154. As a result of these 9/05 and early 10/05 negative revelations about Dell, which
further undermined and contradicted Dell’s prior positive statements about its product quality
and customer support, service and satisfaction, Dell’s stock declined from $35.66 on 9/6/05 to
$31.65 on 10/6, a loss of $10 billion in market capitalization, as further artificial inflation came
out of the stock, damaging prior Class Period purchases. However, while Dell stock declined in
price as a result of these revelations, it remained artificially inflated due to Dell’s failure to make
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full and truthful disclosure and its continuing to make false and misleading statements. For
instance, on 10/20/05, the Technology Report published an article about a presentation by M.
Dell at a huge conference in Canada:
Dell boss bullish on sales growth; Founder sees annual revenue ballooning by $30-billion despite market conditions
Michael Dell doesn’t seem to have heard of any slowdown in the technology sector.
* * *
Dell . . . says foreign expansion and sales to more business based customers will help the Round Rock, Tex., company hit $80-billion in sales in the next few years.
* * *
Mr. Dell . . . denies that the company’s service is slipping and says Dell continually ranks above its competitors. “Part of the issue is just the sheer number of customers that we’re dealing with,” he says.
155. The statements made on 8/11/05, 9/1/05 and 10/20/05, as pleaded above,
impacted and were reflected in the market trading price of Dell stock. These statements
included:
• Dell’s disappointing 2ndQ F06 revenues were due to “misexecut[ion]” because Dell “didn’t get up sell within the consumer business” but that was something “we can fix,” “we’ll get it back in line” and “management had identified and addressed the problem which drove the FQ2 revenue shortfall.”
• Dell had seen “no slowdown,” the Company’s service was not “slipping” and the “Company ranks above its competitors.”
• Dell’s 2ndQ F06 operating margin was 8.7% – an improvement – and Dell “remained committed to reducing costs” as “cost savings initiatives include providing . . . customer support functions from cost-effective locations.”
• Dell’s top officers had reviewed Dell’s internal financial and accounting and disclosure controls. Those controls were effective to assure accurate preparation of Dell’s SEC filings and that no undisclosed deficiencies in Dell’s internal controls or fraud – material or otherwise – existed at Dell.
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These statements were false and misleading. The true undisclosed facts, which were known to or
recklessly disregarded by each of the Dell Defendants, were:
(a) The Dell Direct business model was not operating successfully or creating
the strong, often record, financial results and operating margins Dell was reporting; in fact, due
to overly aggressive cost-cutting in Dell’s customer support and service and manufacturing
operations, Dell’s business model was being afflicted with sky-rocketing customer
dissatisfaction and complaints, as well as increasing product quality problems (especially with
laptop batteries and capacitors). In truth, Dell’s financial results were being falsified and
temporarily inflated by (i) large cost-cuts which would have to be reversed and remediated; (ii)
improper accounting tricks, including under-accruing warranty costs and failing to take timely
write-downs for defective products and product replacement; and (iii) its secret receipt of some
$200 million per quarter in rebate/kickback payments from Intel in return for exclusively
purchasing Intel microprocessors/chips.
(b) Dell was not manufacturing or selling the highest quality products, as
Dell’s aggressive cost-cutting in its manufacturing operations to boost its reported profits in the
short term had badly weakened Dell’s quality control procedures and standards for component
parts, i.e., batteries and finished goods, such that Dell was encountering an upsurge in customer
complaints due to faulty products, including capacitor failures, motherboard failures and
widespread laptop (lithium) battery defects.
(c) Dell did not have an unrivaled ability to create products or technologies
that met or exceeded customer expectations, nor did it have world-class manufacturing
excellence, producing high-quality products. In fact, as a result of the aggressive cost cuts in
Dell’s manufacturing operations, Dell’s quality assurance procedures had become badly
impaired, leading to a marked decline in product quality.
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(d) Dell’s cost-cutting program was resulting in a marked increase in the
production of defective products which did not meet Dell’s historic quality standards and a
marked decline in Dell’s historic levels of customer support and service and thus customer
satisfaction, which Dell insiders knew would cost hundreds of millions, if not billions, of dollars
to remedy, including the hiring of thousands of additional full-time employees to be trained to
staff customer call centers and to improve Dell’s quality assurance techniques and practices in its
manufacturing operations.
(e) In order to cut operating costs, Dell had sharply curtailed its quality
control processes by no longer testing component parts (specifically batteries, hard drives,
optical drives or motherboards and laptop accessory parts, including power adaptors) received
from suppliers. Rather, Dell was relying on post-assembly quick tests of completed units to
discover defective component parts. In addition, it had also curtailed the post-assembly “burn-
in” testing of units, which steps in combination were resulting in Dell shipping much larger
numbers of computers with defects and performance problems, leading to increased quality
problems and customer dissatisfaction.
(f) Dell was not providing superior customer service and support as, due to
overly aggressive cost-cutting activities in Dell’s customer support and service operations to
boost its reported profits in the short term, including moving most of Dell’s consumer and small
business customer support and service call centers to India and the Philippines and replacing full-
time, well-trained employees with part-time, ill-trained (but cheaper) employees, Dell’s customer
support and service operations were badly impaired, resulting in very long wait times and an
inability to adequately respond to customer complaints and questions, generating an upsurge in
customer anger and dissatisfaction with Dell, its products and its customer support and service
which Dell’s internal metrics showed would hurt sales.
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(g) Because of its shifting of much of its customer support and service
operations, especially for its consumer and small business customers, to “call centers” in India
and the Philippines and staffing its call centers with part-time, poorly trained employees, Dell
was no longer providing a superior customer experience or generating high degrees of (or
improving) customer satisfaction. Rather, Dell was encountering a widespread customer revolt
with a massive upsurge in complaints regarding declining product quality and declining service
and support operations and a sharp decline in one of Dell’s key internal metrics – the “likely to
repurchase” number.
(h) The Dell Direct model also was not functioning effectively with respect to
Dell’s direct sales process because Dell had flooded the market with a huge number of confusing
and contradictory promotional offers which its now ill-trained and inadequate sales force was
unable to effectively process. This was leading to refusals to honor many “coupons” and
“promotions,” resulting in customer dissatisfaction and refusal to buy Dell products, which was
showing up in an important internal Dell metric known as the “likely to repurchase” number,
where Dell was seeing soaring negative sentiment which meant customers were displeased with
the Dell sales process and thus Dell’s sales growth would decline.
(i) While Dell publicly disseminated favorable surveys and reports purporting
to show high degrees of Dell customer satisfaction with product quality and service and support,
in fact, its own internal surveys, information and customer metrics (which it constantly
monitored) showed a huge upsurge in customer dissatisfaction with and anger at Dell, including
a measurable increase in negative responses to its most important metric, the so-called “likely to
repurchase” number, which Dell knew indicated serious problems with ongoing sales growth.
(j) Dell’s increasing product quality was not resulting in a decrease in Dell’s
warranty costs. In fact, Dell had quietly curtailed the length of its product warranty and sharply
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curtailed the breadth of its warranty coverage (it had eliminated the computer operating system
from its warranty) and, in addition, had secretly adopted a new “fix-on-fail-only” policy,
whereby it would provide in-home repair service or product replacement only when a computer
(or component) completely failed, as opposed to merely malfunctioned, to cut costs. However,
these severe restrictions in Dell’s warranty and service to its customers – which were much
different than Dell’s historic “customer friendly” approach to warranty, service and product
quality issues – were causing an upsurge in customer dissatisfaction with and anger at Dell,
which Dell insiders knew would inevitably result in declining sales growth and a massive
increase in warranty and product repair costs to try to restore customers’ satisfaction to
acceptable levels.
(k) Dell’s 2ndQ F06 financial statements were artificially inflated and
falsified, as detailed in ¶¶233-273, due to a failure to properly accrue required amounts for
warranty costs, failure to recognize large product defect/recall costs and failure to properly
disclose the existence, nature and extent of the huge rebate payments Dell was receiving each
quarter from Intel.
(l) Dell’s Sarbanes-Oxley representations were false, as Dell’s internal
financial and accounting and disclosure controls were deficient and an undisclosed material fraud
was ongoing at Dell – Dell’s financial statements were being falsified, its disclosures in its SEC
filings were false and misleading and an ongoing fraudulent violation of the securities laws was
occurring.
(m) Dell’s statements regarding its ability to quickly benefit financially from
declines in component part prices was false and misleading. The true reason for Dell’s reported
superior operating margins was, in large part, the hundreds of millions of dollars of secret and
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likely illegal rebate/kickback payments Dell was receiving from Intel at the end of each quarter
in return for purchasing 100% or virtually 100% of its microprocessor requirements from Intel.
(n) Due to customer demand for PCs with the advanced features and
advantages of the new AMD microprocessor chips, Dell had decided it would have to begin to
purchase AMD chips for its computers, which would mean the loss of those hundreds of millions
of dollars of rebate/kickback payments from Intel, which would hurt Dell’s operating profits and
margins.
(o) Dell’s U.S. consumer/small business operations were not “going
gangbusters,” or achieving success, but, in fact, were performing very poorly and well below
expectations due, in large part, to the product quality and customer service and support
deficiencies outlined above.
(p) The Dell Direct business model was not advantaged in all environments
across all regions and in all product categories or able to cause Dell to report solid profits and
rapid growth regardless of prevailing market conditions due to product quality and customer
service and support issues due to the deficiencies and defects detailed above.
(q) Dell’s purported improvements in reducing its operating expenses as a
percentage of net revenues and the reported increases in its net and gross operating profit
margins to record high levels were only being achieved at the cost of the serious product quality
and customer support and service problems outlined above and which the Dell Defendants knew
would require massive expenditures to fix, harming Dell’s profitability going forward.
(r) Due to the material adverse facts and problems set forth above, Dell and
the Dell Defendants knew that Dell could not and would not achieve the revenue, operating
profit, operating profit margins, net income and EPS growth being forecast by them.
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156. After the close of trading on 10/31/05, Dell again surprised investors – revealing
that its financial results for the 3rdQ F06, ending 10/31/05, would be lower than earlier forecast
due in part to a sharp fall in its U.S. consumer business and a huge $450 million write-off – $.14
per share – mostly due to defective parts in its Optiplex desktop personal computers. Word
also spread of large layoffs – some 1,000 employees. Dell’s stock plunged lower on these
negative revelations.
157. On 11/1/05, Bloomberg reported “Dell Shares Slide as Sales Miss Company’s
Forecasts”:
Shares of Dell Inc. . . . posted their biggest decline in more than four years after the company missed its sales forecast for the second straight quarter.
At least three analysts . . . lowered their ratings on the stock. Dell said yesterday that preliminary results show sales were $13.9 billion compared with the $14.1 billion to $14.5 billion it had predicted.
. . . The missed forecast, following a similar shortfall last quarter, indicates . . . Dell won’t be able to repeat the sales growth that averaged 18 percent in the past three years.
* * *
Dell shares, already down 24 percent this year, fell $2.57 to $29.31 at 10:42 a.m. New York time in Nasdaq Stock Market composite trading and sank as low as $29.13, an 8.6 percent drop. That marked the biggest slide since Aug. 17, 2001.
* * *
Dell said it will also have an expense of $450 million, or 14 cents a share, $300 million of which is associated with costs to service desktop PCs that were built with a faulty part supplied by an unnamed company. The part was in some of the Optiplex PCs it sells to businesses, Dell said, without elaborating.
158. On 11/1/05, The Wall Street Journal reported:
Dell warns of sales, profit slump – PC maker cites weakness in U.S. Consumer market and swollen inventories.
DELL INC. warned it would miss its fiscal-third-quarter earnings and sales forecasts, blaming continued weakness in its U.S. consumer business . . . . Dell also said it would take a $450 million charge in the quarter.
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Dell’s troubles come at a time when the world-wide personal-computer market is showing strong gains.
159. On 11/1/05, the Los Angeles Times reported:
Dell Says Sales Miss Forecasts in 3rd Quarter; The PC maker notes that demand in the U.S. and Britain has been disappointing. It also is taking a charge of $450 million
Dell Inc. said Monday that it would report third-quarter sales below forecasts . . . . The shares dropped 6%.
* * *
Sales growth of 11% in the quarter would be the slowest in more than three years and may dash Rollins’ plans to reach $60 billion in sales this year.
“All of a sudden, long-term growth-rate expectations have ratcheted down,” said Chuck Jones of Atlantic Trust Stein Roe in San Francisco.
* * *
Dell shares have tumbled 19% in less than three months on concern that the company won’t be able to maintain its historical pace of sales growth, which averaged 18% in the last three years.
160. On 11/1/05, Moors & Cabot issued a negative report on Dell. It stated:
Downgrading on Numerous, Growing Concerns – Has Dell Lost Its Mojo?
. . . [W]ith the 3FQ miss, we now question Dell’s ability to get back on its previous track. Thus, we are downgrading the stock . . . and again lowering our estimates . . . .
• Our list of concerns has been growing. We have previously expressed concerns about Dell’s . . . customer satisfaction. To this list we now add: . . . concerns Dell has not handled recent product failures well (more on this below), and another quarter of decelerating revenue growth.
. . . Dell now expects 3FQ revenue growth of 11% Y/Y, compared to prior guidance of 13-16%.
* * *
• We believe Dell delayed replacing Optiplex GX270 motherboards that may have had failing capacitors, which could be another blow to its reputation for quality and service. Bulging capacitors, although tough to troubleshoot, fail slowly and thus generally provide early warning flags. Our field checks suggest Dell has
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not been replacing motherboards with bulging capacitors that may been exhibiting symptoms of imminent failure, citing replacement part supply constraints for its “fix on fail” policy.
161. This negative company-specific information contradicted defendants’ prior
representations. Dell’s stock plunged from $32.15 on 10/31/05 to $28.81 on 11/01/05 on 105
million shares – its biggest one-day decline in several years – a loss of almost $10 billion in
market capitalization, as more of the artificial inflation came out of the stock, damaging prior
Class Period purchasers. However, Dell’s stock continued to trade at artificially inflated, albeit
lower, prices, as Dell continued to report false and inflated financial results and continued to
make false and misleading statements.
162. On 11/1/05, Dell held a conference call for analysts, money managers and
institutional investors to discuss Dell’s 3rdQ F06 results. During this call the following
occurred:
[Jim Schneider – CFO:] Thanks, Lynn. While we are disappointed we didn’t reach our revenue target for the quarter we are very pleased with our ability to deliver industry-leading profitability [and] consistent growth in earnings . . . . In the third quarter . . . record earnings grew 18% on a non-GAAP basis.
* * *
Turning to our results for the third quarter we generated . . . . GAAP EPS of $0.25 includ[ing] nonrecurring charges totaling $442 million, or $0.14 per share.
163. On 11/2/05, BusinessWeek Online published an article about Dell, indicating
Dell’s cost cutting to meet earnings forecasts/targets had hurt Dell’s customer support and
service, its product quality and its customer satisfaction upon which its Dell Direct model and
revenue growth depended. The article was headlined and stated:
It’s Bad to Worse at Dell;
Projected sales and earnings shortfalls are the latest signs that Dell’s days of domination over its PC-industry peers may be coming to an end.
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. . . On Oct. 31, Dell (DELL) said it would fall short of both revenue and earnings expectations for its fiscal third quarter. Look beyond the surface, and the long-term situation at the world’s largest PC maker may be even worse.
After years of heady growth, Dell may be coming back to earth. . . . [I]t has now missed expectations for two consecutive quarters. The shortfalls are a sign it may be struggling to slash costs enough to maintain rich earnings, while also lowering prices enough to gain share and keep top-line growth racing along.
* * *
Many observers, including customers, partners, and analysts, fret that Dell may have been cutting costs so much in order to hit financial targets in recent quarters that it has compromised other measures of performance, including customer support and, possibly, product quality.
164. On 11/8/05, Moors & Cabot issued another negative report on Dell:
• It could take at least several quarters – and potentially several years – for Dell to find its mojo, in our opinion.
* * *
• . . . Dell’s main selling points have historically been low prices and superior customer service and support. Yet surveys show customer satisfaction with Dell’s service and support has fallen . . . .
* * *
Is Turnover Increasing . . . and Causing Customer Satisfaction To Decline?
We believe turnover may be increasing among Dell’s sales and support staff and may be causing customer satisfaction issues that may be resulting in Dell losing sales to competing brands.
* * *
As noted previously, we think Dell’s customer satisfaction ratings are deteriorating and could be a drag for two or more years. We are particularly bothered by a discrepancy between Dell management’s comments and the results of a 3CQ05 Technology Business Research (TBR) study of x86 server customer satisfaction, which shows Dell’s ratings continuing a downtrend that began earlier this year. Dell stated recently that it has invested in improving its service and support and that its internal surveys show improvement. Yet TBR noted a marked falloff in Dell’s server support scores in 3CQ05, including both phone support and on-site service. This is not consistent with Dell’s claims its service and support investments are beginning to pay off.
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165. Fortune’s 11/28/05 edition contained an article stating:
The witching hour came, fittingly enough, on Halloween: Dell chief executive Kevin Rollins issued an early warning about the company’s third-quarter financial performance. He probably wished he could hide behind a mask. Earnings and sales would both be below expectations. The company would have to write off $450 million, the bulk of it because of an embarrassingly basic misstep for a firm that prides itself on operational efficiency: the installation of faulty capacitors in a large number of computers. . . .
It was not the kind of surprise Dell watchers had come to expect. For years Dell’s startling announcements have been on the positive end, posting blowout revenue numbers, climbing market share, and rocketing profits. Beating Wall Street’s expectations had become part of the company’s persona . . . .
Suddenly though, it seems that Dell’s best days might actually be behind it. . . . Could this be the end of Dell as we know it?
Founder Michael Dell, still the company’s chairman, evinces no apparent unease, despite the fact that his stock is down 28% since August: “There is no perfect linear path to success,” he told me. “I think the stock market over-reacted.” CEO Rollins goes further: “No, the sky is not falling at Dell,” he says. . . . Our model still works very well.” Changes, Rollins admits, are necessary. But, he says, “we are not talking about wholesale upheaval. We are tweaking, making refinements and enhancements, and resetting.”
166. On 11/28/05, Dell filed its 3rdQ F06 report on Form 10-Q with the SEC, signed
by Hooper. The 10-Q Report contained the same financial results earlier reported and stated:
Operating income and earnings per share declined year-over-year due to charges of $442 million primarily for warranty costs of $307 million for servicing or replacing certain OptiPlex™ systems that include a vendor part that failed to perform to our specifications.
* * *
Results of Operations.
The following table summarizes the results of our operations for the three and none month periods ended October 28, 2005 and October 29, 2004:
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Three Months Ended Nine Months Ended 10/28/05 10/29/04 10/28/05 10/29/04 Dollars % of
Revenue Dollars % of
Revenue Dollars % of
Revenue Dollars % of
Revenue (in millions, except per share amounts and percentages)
Revenue $13,911 100.0% $12,502 100.0% $40,725 100.0% $35,748 100.0% Gross margin $2,251 16.2% $2,313 18.5% $7,241 17.8% $6,520 18.2% Operating expenses
$1,497 10.8% $1,218 9.7% $4,140 10.2% $3,453 9.7%
Operating income
$754 5.4% $1,095 8.8% $3,101 7.6% $3,067 8.6%
Net income $606 4.4% $846 6.8% $2,560 6.3% $2,376 6.6% Earnings per share - diluted
$0.25 N/A $0.33 N/A $1.03 N/A $0.92 N/A
* * *
Our gross margin declined for the third quarter of fiscal 2006 . . . . Our year-over-year decline in the third quarter is due to a product charge of $338 million for estimated warranty costs of servicing or replacing certain OptiPlex™ systems that include a vendor part that failed to perform to our specifications, as well as additional charges for product rationalizations and workforce realignment. . . . As part of our focus on improving margins, we remain committed to reducing . . . warranty costs . . . . Cost savings initiatives include providing certain customer technical support . . . from cost-effective locations . . . .
167. Dell’s 3rdQ F06 report on Form 10-Q also contained the Sarbanes-Oxley
certifications signed by Schneider and Rollins, detailed at ¶¶269-273.
168. On 12/16/05, it was reported that Dell was undertaking a laptop battery recall:
Dell recalls laptop batteries on overheating concerns
. . . Dell Inc. recalled some notebook-computer batteries because of the possibility of overhearing and potential fire risk, the U.S. Consumer Product Safety Commission said Friday.
The consumer watchdog said the recall affects about 22,000 batteries in the United States sold individually and with certain Dell laptop models between Oct. 5, 2004, and Oct. 13, 2005.
* * *
The recall was triggered by three reports of batteries overheating that caused damage to a tabletop, a desktop, and resulted in minor damage to personal items, the commission said.
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169. The 12/16/05 battery recall, coming on the heels of the negative disclosures and
publicity concerning Dell’s products, confirmed the existence of those quality problems and
indicated that Dell’s product quality problems were likely more widespread than earlier revealed.
Dell’s stock fell from $33.06 on Friday, 12/16/05, to $30.82 on Wednesday, 12/21/05 – three
trading days later. This loss of over $5 billion in market capitalization caused some of the
artificial inflation to come out of Dell’s stock price, damaging prior Class Period purchasers.
170. On 2/16/06, Dell reported 4thQ F06 and F06 results that again disappointed
investors with lower-than-forecast sales and profit growth and much lower-than-expected gross
margins. During a 2/16/06 conference call, Rollins made admissions that the cost to Dell of
trying to restore Dell’s damaged customer support and service operations and to try to restore
customer satisfaction would be substantial. He said:
Turning to the customer, we ceded some ground on a core attribute of our Dell direct model, and that is our unparalleled customer satisfaction experience. . . . [W]e deem this unacceptable . . . .
To address capacity issues, we’ve opened or announced 10 global contact centers, including Oklahoma City, Edmonton, Manila, Halle and Gurgaon, India. To improve hold times, we increased our Americas telephone support staff by approximately 20%, and our E-support staff by approximately 60%.
* * *
The Company expects first quarter fiscal year 2007 . . . earnings per share of 39 cents to 41 cents . . . .
171. On 2/16/06, Bear Stearns reported:
[M]argins deteriorated as Dell traded revs for profits in consumer . . . .
. . . DELL’s revenue outlook was disappointing, implying deceleration to 6%-9% YoY growth . . . .
* * *
*** Reflecting Dell’s weaker 1Q07 outlook, we’re lowering ests for FY07 . . . and for FY08 . . . .
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* * *
• Gross margin declines sharply. Gross Margin of 17.84% was well below our estimate of 18.48% by 65 basis points, down 75 basis points sequentially and 70 basis points from the prior year period . . . .
172. On 2/17/06, The Mercury News reported:
The heady days of double-digit growth at Dell Inc. may be numbered.
* * *
Sales . . . rose a . . . modest 13 percent . . . .
On top of that, Dell offered a first-quarter outlook that called for a revenue gain of 6 percent to 9 percent. The forecast drew lots of attention Thursday because it was less than analysts were expecting and because Dell routinely promised increases in the mid-teens just a few quarters ago.
173. On 2/17/06, Bloomberg reported:
Shares of Dell Inc. fell the most in more than three months, on concern that the company may have sliced prices to drive sales last quarter after missing its revenue forecast twice last year. . . .
. . . Dell was a “little bit more aggressive in pricing” on products including notebook PCs to win orders, Chief Financial Officer Jim Schneider said yesterday.
* * *
. . . Profit and sales forecasts for this quarter fell short of projections. Dell said sales growth would slow to 6 percent to 9 percent from 16 percent a year ago.
The company’s shares sank $1.58, or 4.9 percent, to $30.38 at 4 p.m. New York time in Nasdaq Stock Market composite trading.
174. On 2/17/06, SG Cowen & Co. issued a report on Dell:
Puzzling Q4-Q1 Sequence
. . . [G]uidance for Q1 is puzzlingly weak, looked at either Y/Y or vs actual . . . . We are reducing EPS for F07 by a nickel . . . there seems to be a bit of trouble in paradise . . . .
. . . While management defends integrity of model advantages over competition . . . hard not to question whether edge has narrowed.
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175. On 2/21/06, suddenly and without warning, Dell postponed its annual meeting
with analysts/investors scheduled for 4/06 in Austin, Texas, until 9/06. On 2/22/06,
MarketWatch reported:
Dell shares fall in pre-market trades; analyst day postponed
. . . Dell Inc. shares fell about 1% in pre-market trading Wednesday after the No. 1 maker of personal computers postponed its annual analyst meeting, usually held in April, until September. The stock traded down 1.1% to $29.48 on Instinet trading volume that put it among the 10 most active stocks. . . . Dell shares fell 5% last Friday after the firm reported fiscal fourth-quarter PC sales were flat from a year earlier and issued a financial forecast that lagged the expectations of Wall Street analysts.
176. On 2/22/06, JP Morgan issued a report on Dell:
Dell Cancels Analyst Day, Raises Some Near-Term Concerns
• Last night Dell cancelled its analyst day scheduled for April, and rescheduled for September 2006. The abrupt cancellation of the meeting, just days after the company highlighted the event on its earnings call, clearly raises some concerns.
177. On 2/22/06, Bernstein issued a report on Dell:
Following Dell’s disappointing earnings last week, this research piece discusses what we believe are the four key issues coming out of Dell’s results.
• Contrary to our and others’ expectations, Dell did not gain overall PC share in Q4 – which was a big disappointment and is likely to fuel continued debate about Dell’s sustainable growth rate. The biggest issue coming out of Dell’s Q4 results is that Dell didn’t gain PC share in the quarter, despite the fact that its gross margins declined meaningfully and the company had an extra week in the quarter. We note that IDC and Gartner calendar Q4 05 data – which showed Dell was gaining share – was misrepresentative, as Dell’s submitted data to the groups included an extra week . . . .
• Dell’s weakness in consumer is pronounced, which we believe is – in part – attributable to weaker product offerings, particularly consumer notebooks. We note that Dell’s US consumer growth rate has declined from 20%+ to 1% since the beginning of FY2004, and that its operating profit has fallen from 6%+ to 3.8%. Our analysis also suggests that US consumer gross margins fell by a startling 200 bps sequentially.
* * *
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• The strong erosion in Q4 margins . . . is confounding . . . .
178. Due to the negative, company-specific revelations regarding Dell between 2/16/06
and 2/22/06, Dell’s stock fell from $32.24 on 2/15/06 to $28.88 on 2/24/06. This decline caused
an $8 billion loss in market capitalization as more of the artificial inflation came out of Dell’s
stock damaging prior Class Period purchasers. However, while Dell stock declined in price as a
result of these revelations, it remained artificially inflated due to Dell’s failure to make full and
truthful disclosure and its dissemination of false and misleading statements.
179. The statements of 10/31/05, 11/1/05, 11/28/05 and 2/16/06 impacted and were
reflected in the market trading price of Dell stock. These statements included:
• Dell’s 3rdQ F06 and 4thQ F06 financial results.
• Dell’s top officers had reviewed Dell’s internal financial and accounting and disclosure controls. Those controls were effective to assure accurate preparation of Dell’s SEC filings and that no undisclosed deficiencies in Dell’s internal controls or fraud – material or otherwise – existed at Dell.
• Dell was “very pleased with [its] ability to deliver industry-leading profitability [and] consistent growth in earnings” and that in the third quarter the Company’s “record earnings grew 18% on a non-GAAP basis.”
• Dell had taken steps sufficient to “address capacity issues” and to “improve hold times.”
• Dell expected “first quarter fiscal year 2007 . . . earnings per share of 39 cents to 41 cents.”
These statements were false. True undisclosed facts, which were known to or recklessly
disregarded by each of the Dell Defendants, were:
(a) The Dell Direct business model was not operating successfully or creating
the strong, often record, financial results and operating margins Dell was reporting; in fact, due
to overly aggressive cost-cutting in Dell’s customer support and service and manufacturing
operations, Dell’s business model was being afflicted with sky-rocketing customer
dissatisfaction and complaints, as well as increasing product quality problems (especially with
- 156 -
laptop batteries and capacitors). In truth, Dell’s financial results were being falsified and
temporarily inflated by (i) improper accounting tricks, including under-accruing warranty costs
and failing to take timely write-downs for defective products and product replacement; and (ii)
its secret receipt of some $200 million per quarter in rebate/kickback payments from Intel in
return for exclusively purchasing Intel microprocessors/chips.
(b) The Dell Direct model also was not functioning effectively with respect to
Dell’s direct sales process because Dell had flooded the market with a huge number of confusing
and contradictory promotional offers which its now ill-trained and inadequate sales force was
unable to effectively process. This was leading to refusals to honor many “coupons” and
“promotions,” resulting in customer dissatisfaction and refusal to buy Dell products, which was
showing up in an important internal Dell metric known as the “likely to repurchase” number,
where Dell was seeing soaring negative sentiment which meant customers were displeased with
the Dell sales process and thus Dell’s sales growth would decline.
(c) Dell’s increasing product quality was not resulting in a decrease in Dell’s
warranty costs. In fact, Dell had quietly curtailed the length of its product warranty and sharply
curtailed the breadth of its warranty coverage (it had eliminated the computer operating system
from its warranty) and, in addition, had secretly adopted a new “fix-on-fail-only” policy,
whereby it would provide in-home repair service or product replacement only when a computer
(or component) completely failed, as opposed to merely malfunctioned, to cut costs. However,
these severe restrictions in Dell’s warranty and service to its customers – which was much
different than Dell’s historic “customer friendly” approach to warranty, service and product
quality issues – were causing an upsurge in customer dissatisfaction with and anger at Dell,
which Dell insiders knew would inevitably result in declining sales growth and a massive
- 157 -
increase in warranty and product repair costs to try to restore customers’ satisfaction to
acceptable levels.
(d) The SEC had notified Dell it was investigating Dell’s prior financial
reporting practices and SEC filings which Dell’s top insiders knew would likely uncover
numerous irregularities, including under-accruals of warranty obligations, revenue recognition
improprieties and concealment of the Intel rebate/kickback payments.
(e) Notwithstanding the large 3rdQ F06 write-down, Dell’s 3rdQ F06 and
4thQ F06 financial results and statements remained artificially inflated and falsified, as detailed
in ¶¶233-273, due to a failure to properly accrue required amounts for warranty costs, failure to
recognize material product defect/recall costs and failure to properly disclose the existence,
nature and extent of the huge rebate payments Dell was receiving each quarter from Intel.
(f) Dell’s Sarbanes-Oxley representations were false, as Dell’s internal
financial and accounting and disclosure controls were deficient and an undisclosed material fraud
was ongoing at Dell – Dell’s financial statements were being falsified, its disclosures in its SEC
filings were false and misleading and an ongoing fraudulent violation of the securities laws was
occurring.
(g) Due to customer demand for PCs with the advanced features and
advantages of the new AMD microprocessor chips, Dell had decided it would have to begin to
purchase AMD chips for its computers, which would mean the loss of those hundreds of millions
of dollars of rebate/kickback payments from Intel, which would hurt Dell’s operating profits and
margins.
180. In or about 3/06, Dell issued its F06 Annual Report. It contained a reassuring
letter from M. Dell and Rollins, stating:
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In fiscal 2006, Dell continued to outpace the industry worldwide and in every region where we compete – achieving company records for . . . revenue, operating income and earnings per share.
Each milestone resulted from the global execution of our direct business model. It continues to give us a one-of-a-kind ability to listen to millions of customers daily, deliver what each defines as value and provide a superior experience.
No other technology company can rival Dell’s know-how . . . [in] delivering relevant technologies that meet or exceed customer expectations.
* * *
Customer Experience
. . . At Dell, an exceptional customer experience begins with product leadership. And it continues long after the sale as we strive to instill satisfaction, trust and loyalty with each customer contact. Sustaining that continuum has been integral to our success.
* * *
We improved Dell’s overall customer experience considerably in fiscal 2006 . . . .
* * *
We continue to reaffirm the tenets of our direct model: . . . world-class manufacturing; . . . and execution excellence.
181. Dell’s F06 Annual Report included the following financial results and financial
statements which had been audited and certified by PWC:
OPERATING RESULTS (in millions, except per-share data)
Fiscal-year ended Feb. 3, 2006 Jan. 28, 2005
Net revenue $ 55,908 $ 49,205 GAAP gross margin $ 9,950 $ 9,015 GAAP operating income $ 4,347 $ 4,254 GAAP net income $ 3,572 $ 3,043 GAAP earnings per common share $ 1.46 $ 1.18
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182. On 3/15/06, Dell filed its F06 Annual Report on Form 10-K, which was signed by
Schneider, Miles, Carty, Rollins and M. Dell. It contained Dell’s F06 financial results and
statements as audited and certified by PWC. The 10-K stated:
Business Strategy
Dell’s business strategy combines its direct customer model with a highly efficient manufacturing and supply chain management organization . . . . This strategy enables Dell to provide customers with . . . high-quality . . . technology [and] superior service and support . . . .
183. The F06 10-K also included management’s discussion and analysis of financial
condition and results of operation. It stated:
Gross Margin
The following table presents information regarding our gross margin during each of the past three fiscal years:
Fiscal Year Ended February 3, 2006 January 28, 2005 January 30, 2004
Dollars% of
Revenue Dollars% of
Revenue Dollars % of
Revenue (in millions, except percentages) Revenue ...................................... $55,908 100.0% $49,205 100.0% $41,444 100.0% Gross Margin .............................. 9,950 17.8% 9,015 18.3% 7,552 18.2%
In fiscal 2006, our gross margin declined as a percentage of revenue . . . . Our year-over-year decline is primarily due to a product charge of $338 million for estimated warranty costs of servicing or replacing certain OptiPlex™ systems that included a vendor part that failed to perform to our specifications . . . . In fiscal 2005, gross margin as a percentage of net revenue improved slightly to 18.3% compared to 18.2% for fiscal 2004. This year-over-year improvement was primarily driven by our continued cost savings initiatives.
As part of our focus on improving margins, we remain committed to reducing . . . warranty costs . . . . Cost savings initiatives include providing certain customer technical support . . . from cost-effective locations . . . .
184. Dell’s F06 10-K also stated:
Dell’s manufacturing process consists of assembly, software installation, functional testing, and quality control. Testing and quality control processes are also applied to components, parts, and subassemblies obtained from third-party suppliers. Quality control is maintained through the testing of components, subassemblies, and systems at various stages in the manufacturing process. Quality control also includes a burn-in period for completed units after assembly,
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on-going production reliability audits, failure tracking for early identification of production and component problems, and information from Dell’s customers obtained through services and support programs. . . .
Dell purchases materials, supplies, and product components from a large number of suppliers. . . . Dell currently relies on Intel Corporation as a sole source supplier of processors . . . . These relationships and dependencies have not caused material disruptions in the past, and Dell believes that any disruptions that may occur would not disproportionately disadvantage Dell relative to its competitors.
* * *
Through our direct business model, we design, develop, manufacture, market, sell, and support a broad range of information technology systems and services . . . . Our direct model begins and ends with our customers . . . . The unique strengths of our direct model facilitate our consistent delivery of profitability and strong performance across our business segments.
* * *
Operating Expenses
The following table presents information regarding our operating expenses during each of the past three fiscal years:
Fiscal Year Ended (in millions, except percentages)
2/3/06 1/28/05 1/30/04
Dollars % of
Revenue
Dollars % of
Revenue
Dollars % of
Revenue
Operating Expenses: Selling, general, and administrative
$5,140 9.2% $4,298 8.7%
$3,544 8.6%
Research, development, and engineering
$463 0.8% $463 1.0% $464 1.1%
Total operating expenses $5,603 10.0% $4,761 9.7% $4,008 9.7%
* * *
Critical Accounting Policies
We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”). . . . We believe our most critical accounting policies relate to revenue recognition [and] warranty accruals . . . .
* * *
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Warranty – We record warranty liabilities at the time of sale for the estimated costs that may be incurred under its limited warranty. . . . Warranty claims are relatively predictable based on historical experience of failure rates. If actual results differ from our estimates, we revised our estimated warranty liability to reflect such changes. Each quarter, we reevaluate our estimates to assess the adequacy of the recorded warranty liabilities and adjust the amounts as necessary.
185. Dell’s F06 Form 10-K also stated:
ITEM 1B –UNRESOLVED STAFF COMMENTS
None.
186. The statements in Dell’s F06 10-K impacted and were reflected in the market
trading price of Dell stock. These statements included:
• Dell had achieved “record” F06 financial results, including operating income and earnings, which was “primarily driven by our continued cost savings initiatives.” These results reflected properly determined “warranty liabilities” which Dell had made “each quarter” “adjusting as necessary” – Dell faced no unresolved SEC comments.
• Dell’s record F06 results came from “global execution of our direct business model” and “no other . . . company” “can rival Dell’s know-how in delivering” products “that meet or exceed customer expectations,” and Dell had “improved Dell’s overall customer experience considerably in fiscal 2006.”
• Dell had “world class manufacturing” as part of its “execution excellence,” generally “high quality technology” and “superior service and support.”
• Any “disruption” of Dell’s Intel sole source relationship “would not disproportionately disadvantage Dell relative to its competitors.”
• Dell’s top officers had reviewed Dell’s internal financial and accounting and disclosure controls. Those controls were effective to assure accurate preparation of Dell’s SEC filings and that no undisclosed deficiencies in Dell’s internal controls or fraud – material or otherwise – existed at Dell.
These statements were false and misleading. The true undisclosed facts, which were known to or
recklessly disregarded by each of the Dell Defendants, were:
(a) The Dell Direct business model was not operating successfully or creating
the strong, often record, financial results and operating margins Dell was reporting; in fact, due
to overly aggressive cost-cutting in Dell’s customer support and service and manufacturing
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operations, Dell’s business model was being afflicted with sky-rocketing customer
dissatisfaction and complaints, as well as increasing product quality problems (especially with
laptop batteries and capacitors). In truth, Dell’s financial results were being falsified and
temporarily inflated by (i) improper accounting tricks, including under-accruing warranty costs
and failing to take timely write-downs for defective products and product replacement; and
(ii) its secret receipt of some $200 million per quarter in rebate/kickback payments from Intel in
return for exclusively purchasing Intel microprocessors/chips.
(b) Dell was not manufacturing or selling high quality products, as Dell’s
aggressive cost-cutting in its manufacturing operations to boost its reported profits in the short
term had badly weakened Dell’s quality control procedures and standards for component parts,
i.e., batteries and finished goods, such that Dell was encountering an upsurge in customer
complaints due to faulty products, including capacitor failures, motherboard failures and
widespread laptop (lithium) battery defects.
(c) Dell did not have an unrivaled ability to create products or technologies
that met or exceeded customer expectations, nor did it have world-class manufacturing
excellence, producing high-quality products. In fact, as a result of the aggressive cost cuts in
Dell’s manufacturing operations, Dell’s quality assurance procedures had become badly
impaired, leading to a marked decline in product quality.
(d) Dell’s cost-cutting program was resulting in a marked increase in the
production of defective products which did not meet Dell’s historic quality standards and a
marked decline in Dell’s historic levels of customer support and service and thus customer
satisfaction, which Dell insiders knew would cost hundreds of millions, if not billions, of dollars
to remedy, including the hiring of thousands of additional full-time employees to be trained to
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staff customer call centers and to improve Dell’s quality assurance techniques and practices in its
manufacturing operations.
(e) Dell was not providing superior customer service and support as, due to
overly aggressive cost-cutting activities in Dell’s customer support and service operations to
boost its reported profits in the short term, including moving most of Dell’s consumer and small
business customer support and service call centers to India and the Philippines and replacing full-
time, well-trained employees with part-time, ill-trained (but cheaper) employees, Dell’s customer
support and service operations were badly impaired, resulting in very long wait times and an
inability to adequately respond to customer complaints and questions, generating an upsurge in
customer anger and dissatisfaction with Dell, its products and its customer support and service
which Dell’s internal metrics showed would hurt sales.
(f) In order to cut operating costs, Dell had sharply curtailed its quality
control processes by no longer testing component parts (specifically batteries, hard drives,
optical drives or motherboards and laptop accessory parts, including power adaptors) received
from suppliers. Rather, Dell was relying on post-assembly quick tests of completed units to
discover defective component parts. In addition, it had also curtailed the post-assembly “burn-
in” testing of units, which steps in combination were resulting in Dell shipping much larger
numbers of computers with defects and performance problems, leading to increased quality
problems and customer dissatisfaction.
(g) Because of its shifting of much of its customer support and service
operations, especially for its consumer and small business customers, to “call centers” in India
and the Philippines and staffing its call centers with part-time, poorly trained employees, Dell
was no longer providing a superior customer experience or generating high degrees of (or
improving) customer satisfaction. Rather, Dell was encountering a widespread customer revolt
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with a massive upsurge in complaints regarding declining product quality and declining service
and support operations and a sharp decline in one of Dell’s key internal metrics – the “likely to
repurchase” number.
(h) The Dell Direct model also was not functioning effectively with respect to
Dell’s direct sales process because Dell had flooded the market with a huge number of confusing
and contradictory promotional offers which its now ill-trained and inadequate sales force was
unable to effectively process. This was leading to refusals to honor many “coupons” and
“promotions,” resulting in customer dissatisfaction and refusal to buy Dell products, which was
showing up in an important internal Dell metric known as the “likely to repurchase” number,
where Dell was seeing soaring negative sentiment which meant customers were displeased with
the Dell sales process and thus Dell’s sales growth would decline.
(i) While Dell publicly disseminated favorable surveys and reports purporting
to show high degrees of Dell customer satisfaction with product quality and service and support,
in fact, its own internal surveys, information and customer metrics (which it constantly
monitored) showed a huge upsurge in customer dissatisfaction with and anger at Dell, including
a measurable increase in negative responses to its most important metric, the so-called “likely to
repurchase” number, which Dell knew indicated serious problems with ongoing sales growth.
(j) Dell’s increasing product quality was not resulting in a decrease in Dell’s
warranty costs. In fact, Dell had quietly curtailed the length of its product warranty and sharply
curtailed the breadth of its warranty coverage (it had eliminated the computer operating system
from its warranty) and, in addition, had secretly adopted a new “fix-on-fail-only” policy,
whereby it would provide in-home repair service or product replacement only when a computer
(or component) completely failed, as opposed to merely malfunctioned, to cut costs. However,
these severe restrictions in Dell’s warranty and service to its customers – which was much
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different than Dell’s historic “customer friendly” approach to warranty, service and product
quality issues – were causing an upsurge in customer dissatisfaction with and anger at Dell,
which Dell insiders knew would inevitably result in declining sales growth and a massive
increase in warranty and product repair costs to try to restore customers’ satisfaction to
acceptable levels.
(k) Dell’s F06 financial statements were artificially inflated and falsified, as
detailed in ¶¶233-273, due to a failure to properly accrue required amounts for warranty costs,
failure to recognize large product defect/recall costs and failure to properly disclose the
existence, nature and extent of the huge rebate payments Dell was receiving each quarter from
Intel.
(l) Dell’s Sarbanes-Oxley representations were false, as Dell’s internal
financial and accounting and disclosure controls were deficient and an undisclosed material fraud
was ongoing at Dell – Dell’s financial statements were being falsified, its disclosures in its SEC
filings were false and misleading and an ongoing fraudulent violation of the securities laws was
occurring.
(m) Dell’s statements regarding its ability to quickly benefit financially from
declines in component part prices was false and misleading. The true reason for Dell’s reported
superior operating margins was, in large part, the hundreds of millions of dollars of secret and
likely illegal rebate/kickback payments Dell was receiving from Intel at the end of each quarter
in return for purchasing 100% or virtually 100% of its microprocessor requirements from Intel.
(n) Due to customer demand for PCs with the advanced features and
advantages of the new AMD microprocessor chips, Dell had decided it would have to begin to
purchase AMD chips for its computers, which would mean the loss of those hundreds of millions
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of dollars of rebate/kickback payments from Intel, which would hurt Dell’s operating profits and
margins.
(o) Dell’s purported improvements in reducing its operating expenses as a
percentage of net revenues and the reported increases in its net and gross operating profit
margins to record high levels were only being achieved at the cost of the serious product quality
and customer support and service problems outlined above and which the Dell Defendants knew
would require massive expenditures to fix, harming Dell’s profitability going forward.
187. The 4/15/06 edition of The Economist – published on or about 4/10/06 –
contained an article about the AMD suit against Intel, regarding Intel’s secret and possibly illegal
rebate/payments to customers like Dell with Intel exclusive supply agreements, for the first time
calling the payments a “kickback.” It stated:
Intel inside; Antitrust
The world’s biggest chipmaker is about to have its day in court
* * *
At issue . . . is Intel’s use of rebates and marketing funds, which AMD claims is anti-competitive. Intel is accused of discounting its chips in such a way as to make it extremely costly for computer-makers to buy from it anything short of their total requirement. . . . Moreover, Intel gives rebates to computer-makers each quarter. In such a low-margin business, these can make a big difference. . . .
. . . The question, however, is whether the programme is simply a kickback mechanism to reward PC-makers for their loyalty to Intel . . . .
188. Dell’s stock fell from $29.95 on 4/10/06 to $26 on 4/25/06 – 11 trading days – a
$10 billion loss of market capitalization as more of the artificial inflation came out of Dell’s
stock, damaging prior Class Period purchasers.
189. The 7/3/06 edition of BusinessWeek contained the following information,
revealing that Dell had had to hire over 8,000 new employees to try to fix its customer
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service/support problems – a huge number – much larger than earlier disclosed – as Dell
reported having 65,200 employees at 2/3/06:
What Dell is Doing to Win Back Customers
Re “Satisfaction not guaranteed” and “Dell: Facing up to past mistakes” (News: Analysis & Commentary, June 19): We have acknowledged that our service and support for consumer customers did not keep pace in the rapid growth of that market two years ago. Regrettably, we let some of our customers down. Dell’s efforts to restore customer satisfaction include hiring 8,000 new service agents over a three-year period and providing additional training to current agents in our network of 30 global call centers . . . .
190. On 6/21/06 and 7/4/06, The Inquirer, an Internet publication, reported two serious
Dell laptop burning incidents due to battery defects. On 7/6/06, Moors & Cabot issued a report
on Dell, more widely publicizing negative Dell battery incidents:
A Second – and Third – Hunk, a Hunk of Burning Laptop
. . . The Inquirer, which broke the story of a Dell laptop bursting into flames during a conference in Japan, has published a report on two additional burning Dell laptops. Should this story also hit the mainstream press, we believe there is headline risk and potentially negative demand ramifications for Dell. Reiterate Sell rating.
• On July 4th The Inquirer published “My Dell Blew Up Too”, a letter from Rich S. in Pittsburgh. According to Mr. S, a Dell notebook that he bought late last year caught fire under normal use at home in Feb-06. He returned the unit to Dell, who told him the fault was the system board. Mr. S reports that after about three months, a replacement laptop from Dell started having similar problems. Mr. S removed power when it started smoking and discovered “burnt material . . . and smoke residue” covering the memory. According to Mr. S, Dell’s repair center examined the second laptop and told him a fire had occurred on the system board.
• Potential headline risk and potential negative demand ramifications reinforce confidence in our Sell rating. The story of the burning laptop in Japan eventually made its way in Reuters and USA Today. Should this more recent story do the same, we think it could negatively impact demand for Dell PCs.
• For several reasons, we believe this second story of burning Dell laptops could have more impact than its June 21st predecessor.
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191. On 7/10/06, The New York Times reported these increasing adverse battery
incidents in Dell’s computers:
Dell’s Exploding Computer and Other Image Problems
A Dell notebook computer that burst into flames last month in Osaka, Japan, has damaged more than just the conference table where it was smoldering. The incident, publicized in photos on the Internet, has also hurt Dell’s recent attempts to improve its image.
The company said the incident got more publicity than such incidents usually do when they happen to other manufacturers. In part, that is because Dell’s reputation for responsive customer service was already under attack after the company, the world’s largest PC manufacturer, started to cut costs at its call centers last year. Dell, reacting to the savaging it has received on blogs and Web sites over the cuts, recently responded with a program to spend more than $100 million to improve service.
Photos of the flaming and smoking notebook were posted on a technology news Web site called the Inquirer on June 21. The story was passed around to other Web sites and blogs like Consumerist.com. It was also the subject of a brief article carried later that day on the Dow Jones Newswires.
Two days later, Cindy Shaw, a securities analyst with Moors & Cabot, notified her clients about the publicity. Last Thursday, citing reports of a second smoking laptop, this one in Pennsylvania, she advised them that “should this story also hit the mainstream press, we believe there is headline risk and potentially negative demand ramifications for Dell.”
* * *
Dell said its engineers examined and tested what remained of the flaming notebook computer for several days to find the source of the problem. They concluded that the fire was caused by a faulty lithium ion battery cell, but that the problem was unrelated to a recall last year of notebook batteries by the company and several other computer makers.
* * *
Dell said that it found no pattern of battery failure and that the Pennsylvania incident publicized by the Inquirer Web site was caused by a chip problem and not batteries.
The company also directed reporters’ attention to a statement by Norm England, chief executive of the Portable Rechargeable Battery Association, that said, “Based on the millions of lithium ion batteries in use today and the exceptionally small number of cases in which a battery malfunction has occurred, we believe these batteries are safe and reliable.”
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192. As this company-specific negative information entered and was digested by the
market, Dell’s stock fell further – from $24.68 on 7/3/06 to $21.67 on 7/13/06, an $8 billion
market capitalization loss, as more of the artificial inflation came out of Dell’s stock, damaging
prior Class Period purchasers. However, due to Dell’s continued false statements, Dell’s stock
continued to trade at artificially inflated, albeit lower, prices.
193. On 7/11/06, major changes in Dell’s consumer sales practices and consumer
warranty program were announced:
(a) On 7/14/06, the Financial Times reported:
Dell Cuts Rebates to Boost Flagging Growth
Dell, the world’s biggest personal computer maker, yesterday moved to simplify its pricing structure by cutting rebates and other promotional offers to personal and small business customers.
The move marks the latest in a series of attempts to adjust the price structure at the computer maker after pricing mistakes contributed to missed forecasts in three of the past four quarters.
(b) On 7/14/06, The Dallas Morning News reported:
Dell Inc. will cut back on mail-in rebates and other promotional discounts because the deals confuse customers, the company said Thursday.
* * *
Dell has . . . reversed changes on its warranties in response to customers’ wishes, it said. The company increased its basic warranty on Inspiron and Dimension models back to one year from 90 days. And it reinstated warranty coverage for the computer’s operating system.
(c) On 7/14/06, Investor’s Business Daily reported:
Dell Looks To Simplify Shopping By Cutting Back On Rebate Plans
Personal computer giant Dell plans to pare its use of mail-in rebates as part of a move to simplify pricing and boost customer satisfaction.
* * *
Many customers don’t like the rebate process and are confused by all the various promotions.
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* * *
Dell also changed the terms of its warranties . . . in response to customer complaints.
It had cut its warranty coverage from one year to 90 days. Dell restored the original terms and will once again respond to operating system issues under its hardware warranties – a service it had offered in the past.
194. As this information indicating serious problems in Dell’s consumer sales and
product warranty practices was revealed to and digested by the securities markets, Dell’s stock
fell from $22.68 on 7/13/06 to $20.97 on 7/18/06, three trading days later – a loss of $6 billion in
market capitalization, as more of the artificial inflation came out of the stock price, damaging
prior Class Period purchasers.
195. On 7/20/06, Dell again shocked investors with further negative revelations
inconsistent with and undermining its prior Class Period representations, including warning of
another huge financial performance shortfall and declining EPS! On 7/21/06, The Dallas
Morning News reported:
Dell shares tumble after warning on earnings
Investors hammered Dell Inc. shares Friday after the computer maker fell short again on its earnings forecast.
* * *
Dell projected fiscal second-quarter earnings per share of 21 to 23 cents on sales of $14 billion. In May, the company had predicted its second-quarter figures would be similar to the first quarter, when it earned 33 cents per share on sales of $14.2 billion.
Dell’s stock took a dive from the moment the opening bell sounded on Wall Street.
196. On 7/21/06, JP Morgan issued a report on Dell:
Major Structural and Strategic Changes in Order
* * *
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• This shortfall is far more significant than our previous thesis could have envisioned. We had assumed that Dell’s problems were confined to its U.S. Consumer business, but this quarter’s shortfall in commercial suggests we were wrong.
* * *
• At this point, we believe that major structural and strategic actions are necessary to begin a bottoming process for the stock. These changes should include, but not be limited to the following: substantial changes in business leadership structure; significant refinements to the direct model in the consumer space . . . .
197. On 7/21/06, Moors & Cabot issued a report on Dell, indicating that Dell’s
customer service and support problems had not been remedied and were getting worse and its
customer satisfaction was not improving, but worsening:
Better Business Bureau (BBB) Complaints Shed Light on Dell’s Challenges
. . . Based on BBB data, we believe customer satisfaction may be more than an order of magnitude lower for Dell consumers than for H-P consumers after adjusting for market share. We are reducing estimates and our price target to reflect increasing concern about Dell’s customer experience challenges and ability to succeed given current market trends.
• BBB data suggests to us that Dell’s customer experience challenges are extensive. Indeed, the BBB’s website states “The BBB has recently met with Dell Inc. to develop a better understanding of their policies and to discuss the complaint activity.” The BBB does not make similar comments about H-P or Gateway. Based on BBB data, we estimate that for every PC or printer sold to a U.S. consumer a Dell customer may be about 2.5 times as likely to complain to the BBB as a Gateway customer and possibly sixteen times as likely as an H-P customer.
* * *
• Reducing EPS estimates . . . . We are reducing EPS estimates to reflect (1) greater concerns about Dell’s challenges in the consumer segment, which accounted for 9% of FY06 operating profit . . . .
Consumer May Be About 16x as Likely to Complain to the BBB about Dell than about H-P
* * *
Because the BBB serves primarily U.S. consumers and very small businesses (which we believe behave like consumers when it comes to computer equipment),
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we think BBB complaints should be evaluated in light of consumer shipments instead of overall share . . . .
Thus, to put BBB complaints in perspective we compare them to the number of PC and printer units we estimate each vendor sold to consumers and very small businesses. As shown in figure 1, we estimate that for every one million PCs and printers Dell sold to U.S. consumers and very small businesses over the last three years, there were 599 complaints. This compares to 239 complaints for Gateway and 36 complaints for H-P. Thus, for every PC or printer sold to a U.S. consumer, we estimate a Dell customer is about 2.5 times as likely to complain to the BBB as a Gateway customer and possibly sixteen times as likely to complain to the BBB as an H-P customer.
Figure 1: Adjusted for Market Share, We Believe Dell’s BBB Complaints Are Even Higher
Trailing 36 Month Dell Gateway H-P
Estimated # of BBB Complaints per mm U.S. Consumer Units
599 294 36
# of BBB Complaints (Trailing 36 Month as of 7/17/06)
14,088 907 2,069
Estimated Mix of U.S. PCs Sold to Consumers
25% 43% 52%
Estimated # of U.S. Consumer PCs Sold 14.3 3.1 18.1 Estimated # of U.S. Consumer Printers Sold
9.3 0.0 39.5
Estimate # of U.S. Consumer Units Sold 23.5 3.1 57.6 Source: Better Business Bureau, IDC, company reports and Moors & Cabot estimates
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* * *
Figure 2: We Estimate about Half of Dell’s BBB Issues Are Policy Related
For additional perspective, in figures 3 and 4 we adjust the types of BBB complaints about Dell and H-P to reflect their PC and printer sales to consumers and very small businesses. (The BBB does provide not much detail about Gateway.) From this we estimate that for every PC or printer sold to a U.S. consumer, a Dell customer may be about 30 times as likely to complain to the BBB about product issues as an H-P customer and possibly 20 to 25 times as likely to complain to the BBB about service and repair issues as an H-P customer.
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Figure 3: Dell Customers Seem to Complain About Service, Repair and Product Issues
. . . [W]e estimate that for every PC or printer sold to a U.S. consumer, a Dell customer may be more likely to complain to the BBB than an H-P customer by a potential factor of:
1. 9x for Refund/Exchange and Delivery issues, 2. 12x for Guarantee/Warranty issues, 3. 13x for Billing/Collection issues, 4. 21x for Sales Practice issues, 5. 25x for Advertising issues, 6. 59x for Contract issues, and 7. 24x for Other issues.
198. On 7/22/06, The Financial Times reported:
Shares in Dell suffered their biggest single-day fall since the collapse of the dotcom bubble yesterday after the world’s biggest PC maker said sales and earnings would fall short of expectations in the second quarter.
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* * *
Dell’s shares hit a five-year low yesterday . . . .
199. On 7/22/06, the Irish Times reported:
Shares of Dell suffered their biggest single-day fall since the collapse of the dotcom bubble yesterday after the world’s biggest PC maker said sales and earnings would fall short of expectations in the second quarter.
* * *
“Dell, they are having problems because internally they are in disarray,” said Eric Ross, an analyst at ThinkEquity Partner . . . . “Inside Dell, they don’t know where to turn.”
200. On 7/22/06, The Wall Street Journal reported:
Dell to Report Lower Sales and Profit, Signaling Mounting Troubles
Dell Inc. warned that sales and profit will be lower for the fiscal second quarter, in a sign of the deepening troubles facing the world’s largest maker of personal computers as that market stagnates.
201. On 7/22/06, the Los Angeles Times reported:
Dell Shares Plunge After Report; The PC maker’s warning on profit is followed by its stock’s biggest decline in six years . . . .
Dell Inc. shares tumbled nearly 10% on Friday after the world’s largest personal computer maker warned shareholders that second-quarter profit and revenue would fall well short of Wall Street expectations . . . .
It was Dell’s biggest decline in six years, underscoring how badly the company is under siege . . . .
202. On 7/22/06, Bloomberg reported:
The stock tumbled 9.9 percent, the biggest decline in more than five years, after Dell said “aggressive pricing” will cause second-quarter profit to fall to 21 cents to 23 cents a share, missing the 32 cents expected by analysts surveyed by Thomson Financial.
* * *
Dell’s gross margin likely narrowed to 15.2 percent from 18.6 percent a year ago, said UBS AG’s Benjamin Reitzes in New York. . . . The announcements “back our longstanding call that the ‘Dell Era’ is over,” said Reitzes, the No. 3-ranked computer analyst by Institutional Investor.
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203. As this company-specific negative information was revealed and digested by the
market, Dell’s stock fell from $22.46 on 7/20/06 to $18.95 on 7/21/06, on 124 million shares, an
$8 billion market capitalization loss, as more of the artificial inflation came out of the stock
damaging prior Class Period purchasers.
204. The 8/7/06 edition of Barron’s published an article about Dell:
Is Dell at death’s door? . . . Something is seriously wrong as evidenced by the pre-announcement two and a half weeks ago of a huge earnings miss for the July quarter.
* * *
Restore Customer Confidence. Once beloved by its customers, Dell has frittered away much of that trust through inadequate customer service. One measure of the problem: Consumers file complaints about Dell with the Better Business Bureau 16 times more frequently than they do about H-P, after adjusting for the number of each company’s units in circulation, says analyst Shaw.
205. On 8/14/06, Dell confirmed how serious its product quality – and manufacturing –
problems were when it announced a huge computer battery recall – the largest consumer
product recall in history – because of defects in its batteries that could cause explosion or fire.
On 8/15/06, The New York Times reported:
DELL WILL RECALL BATTERIES IN PC’S
Dell is recalling 4.1 million notebook computer batteries because they could erupt in flames, the company said yesterday. It will be the largest safety recall in the history of the consumer electronics industry, the Consumer Product Safety Commission said.
Dell, the world’s largest PC maker, said the lithium-ion batteries . . . were installed in notebooks from April 2004 to July 18 of this year.
* * *
The recalled batteries were used in 2.7 million Dell computers sold in the United States and 1.4 million sold overseas. The total is about 18 percent of Dell’s notebook production during the period in question.
. . . [T]he cost of the recall could exceed $300 million. . . .
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* * *
Dell has been bedeviled by reports of burning laptops in recent months.
* * *
The battery problem is the latest setback for Dell . . . . [I]t has reported lower-than-expected sales and earnings over the last year, sending its stock down more than 40 percent.
206. On 8/15/06, The Wall Street Journal reported:
Dell to Recall 4 Million Notebook-PC Batteries – Fire Threat Led to Action; Problem Is Traced to Parts Manufactured by Sony Unit
Dell Inc. . . . plans to recall more than four million notebook-computer batteries that can overheat and pose a fire hazard.
The Consumer Product Safety Commission said the recall is the largest computer-related recall in the agency’s history.
207. On 8/15/06, the Los Angeles Times reported:
Dell to Issue Battery Recall; After reports that some of its laptops overheated and caught fire, the company will recall the lithium-ion batteries made by Sony.
* * *
The recall, which comes three days before Dell is scheduled to report is second-quarter earnings, adds to the computer giant’s image crisis.
* * *
The same problems prompted Dell to recall about 284,000 batteries in 2001.
208. On 8/15/06, Baird issued a report on Dell:
Battery Recall Another Black Eye . . . .
* * *
• More Bad PR. Battery recall follows negative press concerning Dell notebook computers catching fire. Further, announcement follows December 2005 recall of 22,000 units amid similar concerns. It appears battery issues seem to be plaguing Dell more than other PC vendors, and highlighting product quality and customer service concerns.
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209. After the close of trading on 8/17/06, Dell actually reported the disappointing
2ndQ F07 financial results it had first revealed on 7/20/06. However, Dell now also shocked
investors by revealing that Dell had known that the SEC had been investigating Dell’s
financial practices and accounting since shortly after Dell’s shocking revelations of financial
shortfalls on 8/11/05 – a year earlier! Dell further revealed that contrary to its earlier
representations, it was now purchasing microprocessors from AMD as well as Intel, despite its
prior assurances that it would not do so, which called into question its continuing receipt of the
large rebate payments from Intel. Dell also revealed it had discovered questionable financial
practices in past years and was conducting an internal investigation into these matters. Finally,
Dell admitted to some analysts that Dell’s previously vaunted procurement and supply operations
were impaired, requiring a full-scale re-examination of its procurement and supply operations!
On these further revelations, Dell’s stock fell from $23.35 on 8/17/06 to $20.65 on 8/18/06, on
87 million share volume, a $5+ billion market capitalization loss as further artificial inflation
came out of the stock price, damaging prior Class Period purchasers.
210. On 8/17/06, Dell held a conference call for analysts, money managers and
institutional investors to discuss its 2ndQ F07 results. During the call the following occurred.
[Rollins – CEO:] We’re clearly disappointed with our financial results.
* * *
[Richard Gardner – Citigroup – Analyst:] Just one other follow-up, could you confirm that there was no impact from a precipitous or sharp decrease in Intel co-marketing dollars on the gross margin in the quarter? . . .
[Rollins – CEO:] We would probably not communicate anything on that. It is proprietary. . . . [We] wouldn’t comment on any of our agreements with suppliers.
* * *
[Richard Farmer – Merrill Lynch – Analyst:] Jim and Kevin, first on the SEC informal investigation, I think you said August 2005. Is that date
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accurate? And if it is, why did you wait a year before disclosing it? What is different today versus a year ago?
* * *
[Rollins – CEO:] . . . An informal investigation really starts out as a letter from the SEC just requesting some information from you. At the time we got it, it seemed like we responded to the information. There was really no reason to disclose it at that time. . . .
This has gone on in a deliberate process for about a year. . . . [I]n the course of researching some matters related to a request from them very recently here, we uncovered a couple of issues going back prior to fiscal 2006 that we felt warranted an additional look. We decided . . . we would have an investigation done by our audit committee.
. . . [A]s this goes on more and more people get involved internally, it is really a matter of we’re not trying to necessarily keep this a secret from people, but the longer something like this goes on, we felt like we should disclose it publicly. . . .
[Richard Farmer – Merrill Lynch – Analyst:] If I could just follow-up on that, just qualitatively what are the issues? Is it something to do with services, recognition, or can you just help us understand topically what you’re looking at, understanding that you don’t expect it to be material when you finish the process.
[Rollins – CEO:] I really can’t comment on that since it is under investigation.
211. On 8/18/06, USA Today reported:
Dell’s poor earnings hammer stock; Shares fall 5.5% after hours . . .
. . . Battered PC giant Dell announced more bad news Thursday, including disappointing earnings and a Securities and Exchange Commission inquiry into its finances.
* * *
Dell also said that the SEC began an informal inquiry into its accounting in August 2005.
* * *
Dell shares fell 5.5% to $21.55 in after-hours trading.
212. Dell’s huge financial shortfalls, the SEC investigation of its financial practices
and Dell’s abandonment of its exclusive microprocessor purchase practices with Intel caused
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certain observers to figure out that the collapse in Dell’s financial performance – especially when
computer hardware component prices had continued to fall – could only have resulted from
Intel’s stopping or curtailing its rebate/kickback payments to Dell, which had been boosting
Dell’s operating income and profit margins, either because they were illegal or because Dell
had begun to purchase microprocessor chips from AMD. For instance, on 7/23/06, when Dell
first revealed that its 2ndQ F07 results would fall far short of forecasted levels, Deutsche Bank
issued a report on Dell:
In a rapidly declining component cost environment, Dell’s margins collapse?
Over the past several months, the pricing environment for both LCDs and CPUs has been very favorable. . . . Typically, these conditions play to the advantage of PC vendor’s [sic] cost models . . . particularly to Dell’s due to its high inventory velocity. Something doesn’t add up.
* * *
Why did margins collapse?
Dell pre-announced F2Q07 to the downside, with sales now expected to be $14B and EPS to be $0.21-$0.23 vs. Street at $14.3B and $0.32. . . . [W]e find the magnitude of the margin miss puzzling given the component pricing environment . . . .
* * *
Some contacts have indicated that Intel negated Dell’s pricing benefit resulting from its exclusive relationship with Intel (legal pressure?). This has many in the industry expecting Dell to add AMD to its desktop lines in order to improve its CPU cost position and negotiating leverage with Intel as early as September.
213. Then, on 8/17/06, after Dell confirmed these horrible operating results and
disclosed the SEC investigation and its abandonment of its exclusive supply arrangement with
Intel, Deutsche Bank issued another report on Dell:
Despite significant price declines in processors . . . we believe Dell suffered from fewer marketing dollars from Intel, which likely hurt results Q/Q. Perhaps not coincidentally, Dell announced an expanded relationship with AMD . . . .
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Surprise SEC investigation announced
Dell also announced that it received a notice in August 2005 from the SEC indicating an informal investigation into Dell’s revenue recognition and other accounting and financial reporting matters for certain past periods.
* * *
So what’s really going on? We believe Dell . . . likely lost significant “co-marketing” dollars from Intel this quarter, either as a result of Dell’s decision to start using AMD processors or resulting from AMD’s lawsuit against Intel. We believe the net effect was higher components costs for Dell . . . .
214. Other observers agreed. On 8/17/06, Thomas Weisel Partners issued a report on
Dell based on its 8/17/06 conference call:
* Lower gross margin weighs on the EPS; no clarity from management . . . . [T]he only logical conclusion is that Dell lost a large subsidy from Intel (100bp-plus), but management refused to comment on this issue.
215. On 8/17/06, TheStreet.com issued an article on Dell:
SEC Probes Dell’s Books
Dell’s profit fell by nearly 50% from the same time last year, as the world’s No. 1 PC maker announced a federal investigation into its accounting practices.
Thursday’s news about the SEC inquiry marks another setback for the company. According to Dell, the company “has discovered information that raises potential issues relating to certain periods prior to fiscal 2006” . . . .
* * *
And Dell executives said Thursday that the company’s vaunted procurement and assembly operations were no longer performing up to par. . . .
Chairman Michael Dell said the company was undertaking a full re-examination of all procurement and supply chain practices.
216. On 8/18/06, BusinessWeek Online reported:
What wasn’t expected was a probe by the U.S. Securities & Exchange Commission. . . .
DELL DEALT A BLOW. But on the heels of a report this week that Dell has to recall more than 4 million defective batteries and amid ongoing concerns over poor customer service, news of slumping profit and an SEC
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investigation left investors dismayed. Shares dropped more than 5% in extended trading, to $21.55.
* * *
INTEL FACTOR. Another number that raised eyebrows: a drop in gross margin to 15.5% from 18.6% a year earlier. Some analysts speculated that at least part of the margin squeeze came as a result of Dell’s changing relationship with Intel . . . . The theory is that as Dell began using AMD chips, Intel cut back on contributions to Dell’s marketing efforts. . . .
“I think it took Dell such a long time to get to using AMD chips because it was getting a pretty big subsidy,” says Charles Wolf, analyst with Needham & Co. in New York.
217. On 8/18/06, The Financial Times reported:
Patience with Dell is starting to wear thin – Analysts suggest internal problems rather than market difficulties are hampering PC maker’s turnaround, says Kevin Allison.
* * *
“Dell’s dramatic miss on both the revenue and gross margin side highlights just how difficult the resolution [of] Dell’s issues is going to be,” says Laura Conigliaro, analyst at Goldman Sachs.
* * *
“Dell cited aggressive pricing and a slower commercial market,”. . . “But Dell has been blaming the market for some time, while we see much of the fall as Dell-centric,” [said Andrew Neff, an analyst at Bear Stearns.]
Ms. Conigliaro agrees that Dell’s problems are largely its own. “[The] Dell miss is largely about Dell itself,” she says.
218. On August 18, 2006, Investor’s Business Daily reported:
Dell’s Profit Falls; Reveals SEC Probe; Woes Mount For PC Leader; “Real stinker” of a quarter comes after product recall . . .
* * *
“It was a real stinker without a doubt,” Morningstar analyst Mark Lanyon said about Dell’s results.
The poor earnings and the SEC investigation – on top of a major product recall that Dell announced earlier this week – make it look like “a snake-bitten company,” Lanyon said.
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219. On 8/24/06, The Financial Times reported:
Dell freezes over THE LEX COLUMN
Talk about crashing and burning. As if Dell’s share price collapse was not enough, it was forced to recall 4.1m spontaneously combustible batteries.
It is no secret that Dell is malfunctioning. . . . Dell’s operating margins have shrunk from more than 8 per cent in recent years to 4.3 per cent.
* * * Dell’s execution has been poor . . . . Dell’s profitability has also been squeezed by the cost of improving customer service and higher-than-expected component prices. The former is an extra cost of doing business. The latter should be corrected to an extent following its woefully late use of AMD chips.
220. On 8/30/06, The Wall Street Journal published an in-depth investigatory story,
detailing many of Dell’s internal customer call center service and support operations problems
and how its 2003-2004 cost cuts hurt its product quality and customer service, support and
satisfaction. It stated:
Consumer Demand and Growth In Laptops Leave Dell Behind – Company’s Corporate Focus Backfires as H-P Thrives . . . High Turnover at Call Centers
* * *
As the tech downturn ended around 2003, Dell continued cutting costs . . . . Around that time, Dell executives decided to hire temporary workers to man their five U.S. call centers, rather than recruit more-expensive full-time staff. By 2005, 75% of Dell’s call-center staff – those who take calls from customers wanting to buy a PC – were temporary workers. Three years earlier, the majority of those staffers were full-time employees.
The move backfired. By late 2005, Dell noticed its U.S. consumer sales were flattening. Ro Parra, a Dell senior vice president who was asked to look at the problem, pinpointed call-center problems as one cause. He discovered that the temporary call-center workers who wanted full-time jobs weren’t being promoted. Turnover in the centers had soared to 300% a year from 30% in 2002.
“. . . [W]e made those decisions that work with the short term, but they were really damaging to us over the long term,” says Mr. Parra.
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221. With this widespread publicity and analyst hostility, even Rollins and M. Dell had
to make some admissions concerning the serious mistakes Dell had made:
(a) On 8/28/06, Barron’s published an interview with M. Dell and Rollins:
COULD DELL BE ANY FURTHER IN THE DOGHOUSE?
Over the past 12 months, the giant personal-computer maker has repeatedly fallen short of its growth targets, attracted widespread complaints about customer service and, recently, recalled 4.1 million laptop batteries. Little wonder the stock (ticker: DELL) is down nearly 40% from a year ago, to about 22.
* * *
Barron’s: There’s been a flood of negative comments about Dell from Wall Street, and a sense that the company is in denial about its problems. How does that all make you feel?
* * *
Rollins: . . . On the whole, I think we have been pretty open about admitting the various mistakes we have made.
* * *
[Barron’s:] What’s the outlook for revenues and margins to improve from these depressed levels?
Rollins: We are no longer forecasting our quarters, so I won’t tell you or anyone else what we expect our revenues or earnings to be.
* * *
[Barron’s:] It looks like a big part of the problem is lower consumer satisfaction. Some point to numbers from the Better Business Bureau showing complaints about Dell running at 16 times those for Hewlett-Packard. What’s going on here?
Rollins: . . . [Y]es, our customer satisfaction did come down . . . because we cut back there. . . .
Dell: Yes . . . our customer support declined . . . . The problems were of our own making and we can’t blame them on the market. . . .
[Barron’s:] Give us a sense of the service improvements that you’re planning.
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Rollins: Among other things, we are spending an extra $150 million to improve our U.S. customer call centers, raising the quality of our agents, reducing hold times, working to ensure the problem is solved on the first call and ensuring that callers are not transferred and re-transferred between experts.
(b) The 9/18/06 edition of Fortune contained an article entitled “Dell In the
Penalty Box.” It stated:
August was the cruelest month for the computer company . . . . In close succession, Dell Inc. recalled 4.1 million laptop batteries because of fears they might ignite, announced a shockingly bad quarter – profits down 51% from a year earlier – and disclosed that the SEC has launched an informal investigation of its accounting. The company’s stock, already down 25% for the year, fell further.
* * *
While the company long had a reputation as the one PC maker that would never let customers suffer a broken machine for long, after-sale service at Dell degraded abysmally in the past couple of years. Dell shifted a large portion of its call centers to India, the Philippines, and elsewhere, and began using scads of temporary workers. “They put a knife in their own heart,” Nick Donatiello, CEO of Odyssey, a San Francisco consulting firm, told me. In the much-watched annual University of Michigan American Customer Satisfaction Index, Dell’s score dropped sharply in 2005, landing for the first time at only the industry average. The company’s internal “likely-to-repurchase” scores showed a decline that was equally disturbing.
“The team was managing cost instead of managing service and quality,” Michael Dell confesses. Managers were evaluating call-center employees primarily on how long they stayed on each customer call. That guaranteed customers would be unhappy and, with their problems unresolved, would call again, angrier still. This year the centers started measuring how well the problem is solved the first time. It also used to be that if a customer called with a Microsoft Office problem, they were told to call Microsoft. No more.
The company has hired “thousands” of people – “most of them in North America,” Michael Dell pointedly adds. It has dramatically reduced the use of temporary employees. It is eliminating most coupons, promotions, and rebates, settling instead on an everyday-low-price model.
* * *
Another necessary move, and one that Dell and Rollins admit took too long, was putting microprocessors from AMD in the company’s products. For about two years AMD has built processors that are faster and/or more energy-efficient than Intel’s in several categories. AMD’s prices lists were lower too,
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but until May, Dell alone among major PC makers refused to sell them. Now Michael Dell says with emphasis, “We overestimated Intel and underestimated AMD in prior periods.”
(c) The Fortune article also contained a separate interview with M. Dell. It
stated:
On Dell’s customer-service woes
We were doing some things that were just plain wrong. Last year we had parts of our company where we would say, “Hey, let’s handle the calls faster.” The problem is that if you handle the call faster, you solve 90% of the problem instead of 100%. So the guy calls back. And you’ve just pissed him off more, and you haven’t accomplished a damn thing.
* * *
The team was managing cost instead of managing service and quality. It’s totally the wrong answer.
222. Finally, on 9/11/06, Dell revealed that due to the ongoing investigations of its
financial statements for past years, Dell could not make the financial filings required by SEC
and Nasdaq rules! Dell also revealed it had received a criminal investigation subpoena from
the U.S. Attorney for the Southern District of New York for materials related to its accounting
practices in recent years and again postponed the analyst meeting it had earlier postponed in
2/06. On 9/11/06, The New York Times reported:
Dell Delays Financial Filing As Accounting Inquiry Grows
Dell, the world’s largest computer maker, said on Monday that it was delaying the filing of its second-quarter financial report as it works to cooperate with a widening investigation into its accounting practices.
The company said that the United States attorney for the Southern District of New York had begun an investigation into Dell’s accounting and that documents related to its financial reporting from 2002 to the present had been subpoenaed.
* * * Dell also said on Monday that it . . . postponed an annual meeting of
financial analysts scheduled for Wednesday.
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News of the wider investigation could hardly have come at a worse time for Dell . . . .
223. On 9/12/06, The Wall Street Journal reported:
Expanding Investigations Increase the Heat on Dell
The hole for Dell Inc. seems to be getting deeper.
The computer maker said it would delay filing its financial second-quarter report because of a widening Securities and Exchange Commission investigation and its own probe into its financial accounting. Dell also said it has been subpoenaed by the U.S. attorney for the Southern District of New York over its financial reporting.
* * *
In addition, Dell canceled its financial-analysts’ day for the second time this year; the meeting with Wall Street analysts was to have taken place in New York tomorrow.
Yesterday, Dell shares slid 2.1%, down 46 cents to $21.19 . . . .
* * *
“A big part of this is it further undermines management credibility, which is already very low,” said Tony Sacconaghi, analyst with Sanford C. Bernstein & Co. “Certainly the finger is going to be pointed most squarely at Kevin Rollins and CFO Jim Schneider.”
224. On 12/19/06, Schneider was replaced as Dell’s CFO and it has been publicly
reported that European Union investigators have recommended that the European Antitrust
Commission formally charge Intel with illegally thwarting any competition in the computer chip
market due to the “exclusivity” discounts provided PC manufacturers, including Dell.
INTEL’S LIABILITY
225. Intel sells microprocessors/chips for computers to PC manufacturers like Dell
around the world. The microprocessor/chip is the brains of a PC. It is by far the most expensive
and critical component part of a PC. Intel is a public company and its top executives are
thoroughly familiar with the financial reporting and disclosure requirements of public companies
like Dell. Most of the other computer OEMs which Intel supplied are also public companies.
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Dell was one of Intel’s two largest customers. In order to improve its competitive position vis-à-
vis other manufacturers of microprocessors/chips, especially its principal domestic competitor,
AMD, Intel secretly paid very large, end-of-quarter cash rebates to PC OEMs that purchased all
or virtually all of their microprocessor/chip requirements from Intel. These rebates, which were
in fact kickbacks, were not traditional volume-based discounts. These monies were paid separate
and apart from and in addition to certain publicly known, co-marketing funds which Intel made
available to certain of its customers to assist in product advertising featuring the “Intel” name.
226. While Intel and AMD have long been competitors, Intel long held the dominant
position, controlling the lion’s share of the PC microprocessor market. However, in 2001, AMD
had gained share for five years straight. Its unit share hit 21.8%, but then suddenly fell to 9% in
mid-2004, as Intel went into Japan and gave the Japanese computer makers millions of dollars in
rebates for varying degrees of exclusivity – in some cases 100%. In 2002-2003, Intel stepped up
its exclusivity rebate/kickback tactic worldwide when it saw itself falling behind AMD
technologically, as AMD developed superior microprocessors/chips.
227. Intel’s ability to use its exclusivity rebates/kickbacks to control the purchasing
decisions of the computer makers stemmed from the commoditization of the computer-making
business, which drove prices lower and left most PC manufacturers with thin operating margins.
Because of the computer manufacturers’ narrow margins, Intel’s payments of end-of-quarter
rebates often determined whether the publicly owned PC manufacturers “hit” their quarterly
numbers. These payments became the industry’s “heroin,” as AMD founder Jerry Sanders has
put it. Because the payments were non-contractual, Intel could stop making them at any time.
228. The secret rebate/kickback payments Intel provided customers in return for
exclusive or near-exclusive dealings were of dubious legality and secrecy and deception of the
public markets and regulators was key. To keep them secret, Intel did not disclose the nature or
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existence of its exclusive-dealing payments to Dell in its SEC filings or other public disclosures.
And Intel also insisted that its customers, like Dell, not publicly disclose the existence of these
rebate/kickback payments in their communications with securities markets or their SEC filings.
This not only made Intel’s SEC filings deceptive and false, it also contributed to the scheme by
keeping this information from analysts that followed Dell and evaluated its business model and
profitability. Intel monitored and reviewed Dell’s SEC filings to make sure Dell was not
disclosing the rebate scheme. This secrecy was required because Intel feared that if these
payments became known, antitrust officials in various countries would likely take legal action
against Intel. Intel customers, like Dell, who accepted these cash rebate payments from Intel
became very dependent upon these payments, which were made by Intel in cash at or near the
end of the customer’s quarter, as they had a direct, material and positive impact on the reported
operating profits and profit margins of the company receiving the rebate/kickback. Dell did not
want the nature or extent of the Intel payments to become known as, due to their dubious legality
and uncertainty, analysts would discount their value to Dell and Dell’s operating profitability and
margins would not be perceived to be nearly as strong as they were – which would hurt Dell’s
stock price. Therefore, Intel and Dell agreed that in return for receiving these large quarter-end
payments, Dell would not disclose the existence or amount of the payments Dell was receiving
relating to the Intel exclusive-dealing rebate/kickback scheme.
229. Intel knew that the existence and amount of the payments Dell was receiving from
it pursuant to the exclusive-dealing rebate/kickback payment scheme were material to Dell’s
reported financial results, especially its operating profit margins, that Dell was not disclosing this
information and that, as a result, Dell’s SEC filings, financial statements and other
communications with the securities markets were false and misleading. Intel is sued in this
action for a violation of §10(b) and Rule 10b-5(a)-(c) for participation in a scheme to defraud
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and course of business that operated as a fraud or deceit on the purchasers of Dell’s publicly
traded securities during the Class Period.
230. During the first half of 3/05, information became public that Intel was violating
the antitrust laws by paying huge kickbacks to customers (computer manufacturers) to get them
to buy microprocessor chips only from Intel. For instance:
(a) On 3/4/05, Japanese regulators had determined that Intel was violating
Japan’s antitrust laws by paying secret rebates, i.e., kickbacks, to Japanese computer
manufacturers in return for their purchasing microprocessors exclusively from Intel. A report
stated:
Japan’s Fair Trade Commission will rule against a local unit of the world’s leading microchip maker Intel Corp. over suspected violation of anti-monopoly laws, a report said Friday.
Intel has been under investigation on allegations that it pressured its customers to limit their procurement from rival firms in exchange for discounts on Intel products.
(b) On 3/7/05, the San Jose Mercury News reported on the Japanese antitrust
proceeding against Intel:
Japan reportedly accuses Intel of antitrust violations
Japanese newspapers are reporting Japan’s government has found Intel in violation of the country’s antitrust laws.
* * *
Yomiuri Shimbun reported that the agency found Intel offered discounts on is microprocessors to computer makers in Japan provided they agreed to limit purchases of chips from competing manufacturers.
(c) On 3/8/05, it was reported that the JFTC had ordered Intel to cease and
desist conduct which violated Section 3 of the Antimonopoly Act (Private Monopolization).
According to the JFTC, since 5/02, Intel had paid the five major Japanese computer OEMs
rebates and/or certain funds referred to as “MDF” (Market Development Funds) on the
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condition that the Japanese OEMs purchase 100% of their microprocessors from Intel and
refrain from adopting competitors’ microprocessors. From these reports, it appeared that Intel
did not contest the charges of the JFTC and that Intel’s illegal kickback payments to its
customers in Japan would cease.
231. AMD’s 6/05 complaint against Intel laying out the rebate scheme in detail, was
not filed until the Japanese authorities went after Intel for this illegal scheme and until after
AMD’s lawyers concluded months’ worth of interviews with persons with first-hand knowledge.
AMD’s lawyers then assembled the highlights into a 48-page complaint which AMD filed in
federal court. The complaint challenged Intel’s alleged misconduct not just with five Japanese
computer makers, but also with more than 30 other industry participants around the world –
including Dell. “It’s an Academy Award-winning complaint,” commented a private antitrust
lawyer who is a former FTC policy director. Within weeks of the filing, EC competition
regulators raided Intel’s offices in England, Germany, Italy and Spain. In 2/06, South Korean
regulators raided Intel’s offices in Seoul and it has been publicly reported that European Union
investigators have recommended that the European Antitrust Commission formally charge Intel
with illegally thwarting any competition in the computer chip market due to the “exclusivity”
discounts provided PC manufacturers, including Dell.
232. Key to the AMD complaint and the Intel rebate/kickback scheme are allegations
of the “first dollar rebates” Intel offered. The rebates worked like this. Suppose XYZ computer
maker needs 100 chips per quarter, and that during the last quarter it bought 90 from Intel and 10
from AMD. Since AMD wants to grow, it might bid for 20 of XYZ’s 100 units in the new
quarter. Intel tells XYZ that its price per processor is, say $90, but that if XYZ ends up buying
more than 80% of its processors from Intel that quarter, it will pay a rebate of $10 per processor,
resulting in an $80 price. The rebate, however, applies not just to the processors that put XYZ
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over the 80% target, but to every Intel processor XYZ purchases that quarter, back to the first
one. This resulted in a large, subjective, non-contractual payment to Dell which boosted its
reported operating margins, making the Company’s operations and its business model look more
profitable and effective and efficient than they really were.
DELL’S MISLEADING FINANCIAL STATEMENTS AND DISCLOSURES
233. Dell’s financial statements and related disclosures during the Class Period were
materially false and misleading due to the Company’s failure to properly and promptly accrue
losses for warranty costs associated with its defective OptiPlex™ products. Dell also failed to
disclose that an important component of its gross profit and operating income was a quarterly
rebate it received from Intel for Dell purchasing a certain percentage of its chips from Intel. The
rebate was at Intel’s discretion, was possibly illegal, was material to Dell’s financial statements
and was not guaranteed to Dell. Yet contrary to accounting and SEC rules, Dell failed to
disclose this key aspect of its earnings. These practices made Dell’s reported operating results
not indicative of the true nature of Dell’s underlying business nor of the business trends investors
could expect based on those results. Dell’s failure to take charges to reflect the warranty
obligation it had and to disclose the Intel rebates was a violation of GAAP and SEC rules.
234. GAAP are those principles recognized by the accounting profession as the
conventions, rules and procedures necessary to define accepted accounting practice at a
particular time. SEC Regulation S-X (17 C.F.R. §210.4-01(a)(1)) states that financial statements
filed with the SEC which are not prepared in compliance with GAAP are presumed to be
misleading and inaccurate, despite note or other disclosure. Regulation S-X requires that interim
financial statements must also comply with GAAP, with the exception that interim financial
statements need not include disclosure which would be duplicative of disclosures accompanying
annual financial statements. 17 C.F.R. §210.10-01(a).
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235. Dell has now acknowledged that the SEC and U.S. Attorney are conducting
investigations of the Company’s past financial statements, involving “accruals, reserves and
other balance sheet items.” This is indicative of the type of manipulations Dell has engaged in
related to warranty accruals and concealing the rebates from Intel if it is not related directly to
these items. The subpoenas relate to Dell’s financial statements since 2002, i.e., prior to and
through the entire Class Period.
236. Dell’s reported financial results for F02-F07 are set forth below:
DELL COMPUTER CORPORATION
Quarterly & Annual Financial Results (in Millions, except EPS)
Fiscal 2002 5/4/01 8/3/01 11/2/01 2/1/02 Year Net Revenue $8,028 $7,611 $7,468 $8,061 $31,168Gross Profit $1,448 $1,330 $1,313 $1,416 $5,507Gross Margin 18.0% 17.5% 17.6% 17.6% 17.7%Operating Income $588 $545 $544 $594 $2,271Oper/Exp/Revenue 10.7% 10.3% 10.3% 10.2% 10.4%Operating Margin 7.3% 7.2% 7.3% 7.4% 7.3%Net Income $462 $433 $429 $456 $1,780Diluted EPS 0.17 $0.16 $0.16 $0.17 $0.65 (1) (1) Fiscal 2003 5/3/02 8/2/02 11/1/02 1/31/03 Year Net Revenue $8,066 $8,459 $9,144 $9,735 $35,404Gross Profit $1,391 $1,515 $1,662 $1,781 $6,349Gross Margin 17.2% 17.9% 18.2% 18.3% 17.9%Operating Income $590 $677 $758 $819 $2,844Oper/Exp/Revenue 9.9% 9.9% 9.9% 9.9% 9.9%Operating Margin 7.3% 8.0% 8.3% 8.4% 8.0%Net Income $457 $501 $561 $603 $2,122Diluted EPS $0.17 $0.19 $0.21 $0.23 $0.80 Fiscal 2004 5/2/03 8/1/03 10/31/03 1/30/04 Year Net Revenue $9,532 $9,778 $10,622 $11,512 $41,444Gross Profit $1,748 $1,778 $1,935 $2,091 $7,552Gross Margin 18.3% 18.2% 18.2% 18.2% 18.2%Operating Income $811 $840 $912 $981 $3,544
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Oper/Exp/Revenue 9.8% 9.6% 9.6% 9.6% 9.7%Operating Margin 8.5% 8.6% 8.6% 8.5% 8.6%Net Income $598 $621 $677 $749 $2,645Diluted EPS $0.23 $0.24 $0.26 $0.29 $1.01 Fiscal 2005 4/30/04 7/30/04 10/29/04 1/28/05 Year Net Revenue $11,540 $11,706 $12,502 $13,457 $49,205Gross Profit $2,073 $2,134 $2,313 $2,495 $9,015Gross Margin 18.0% 18.2% 18.5% 18.5% 18.3%Operating Income $966 $1,006 $1,095 $1,187 $4,254Oper/Exp/Revenue 9.6% 9.6% 9.7% 9.7% 9.7%Operating Margin 8.4% 8.6% 8.8% 8.8% 8.6%Net Income $731 $799 $846 $667 $3,043Diluted EPS $0.28 $0.31 $0.33 $0.26 $1.18 Fiscal 2006 4/29/05 7/29/05 10/28/05 2/3/06 Year Net Revenue $13,386 $13,428 $13,911 $15,183 $55,908Gross Profit $2,491 $2,499 $2,251 $2,709 $9,950Gross Margin 18.6% 18.6% 16.2% 17.8% 17.8%Operating Income $1,174 $1,173 $754 $1,246 $4,347Oper/Exp/Revenue 9.8% 9.9% 10.8% 9.6% 10.0%Operating Margin 8.8% 8.7% 5.4% 8.2% 7.8%Net Income $934 $1,020 $606 $1,012 $3,572Diluted EPS $0.37 $0.41 $0.25 $0.43 $1.46 (2) (2) Fiscal 2007 5/5/06 8/4/06 Net Revenue $14,216 $14,094 Gross Profit $2,472 $2,190 Gross Margin 17.4% 15.5% Operating Income $949 $605 Oper/Exp/Revenue 10.7% 11.2% Operating Margin 6.7% 4.3% Net Income $762 $502 Diluted EPS $0.33 $0.22 (3) (3) (1) Excluding special charges (2) Includes project charges in Cost of Revenue of $338 million for servicing certain OptiPlex systems from a vendor part that failed, plus $104 million in SG&A Expenses for workforce realignment expenses. (3) Includes $77 million and $81 million in stock based compensation expenses, for the 1stQ and 2ndQ F07, respectively.
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Dell’s Failure to Properly Account for Warranty Liabilities
237. GAAP, as set forth in FASB Statement of Concepts (“Concepts”) No. 5, requires
that an entity record a loss when it becomes apparent that an asset has been impaired. See
Concepts No. 5, ¶87. According to GAAP, as set forth in Statement of Financial Accounting
Standard (“SFAS”) No. 5, Accounting for Contingencies, an entity shall record a loss
contingency when information available prior to the issuance of the financial statements
indicates (a) it is probable an asset is impaired or a liability has occurred, and (b) the amount of
loss can be reasonably estimated. See SFAS No. 5, ¶8.
238. A significant contingency under both GAAP (as per SFAS No. 5) and for Dell’s
business was obligations related to product warranties and product defects. SFAS No. 5, ¶4b.
One of Dell’s critical accounting policies was warranty accruals. The 2004 Form 10-K stated in
part: “Dell believes its most critical accounting policies relate to revenue recognition, warranty
accruals, and income taxes.”
239. Dell represented the following with respect to its accruals for warranty liabilities,
indicating that its estimates were “relatively predictable” and that it adjusted its accrual each
quarter:
Warranty – Dell records warranty liabilities at the time of sale for the estimated costs that may be incurred under its basic limited warranty. The specific warranty terms and conditions vary depending upon the product sold and country in which Dell does business, but generally includes technical support, repair parts, labor, and a period ranging from 90 days to three years. Factors that affect Dell’s warranty liability include the number of installed units currently under warranty, historical and anticipated rates of warranty claims on those units, and cost per claim to satisfy Dell’s warranty obligation. The anticipated rate of warranty claims is the primary factor impacting Dell’s estimated warranty obligation. The other factors are relatively insignificant because the average remaining aggregate warranty period of the covered installed base is approximately 20 months, repair parts are generally already in stock or available at pre-determined prices, and labor rates are generally arranged at pre-established amounts with service providers. Warranty claims are relatively predictable based on historical experience of failure rates. Each quarter, Dell reevaluates its estimates to assess
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the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.
240. In fact, Dell did not adequately accrue warranty liabilities, specifically for its
OptiPlex™ products, which later led to a $307 million charge to account for significant
unaccrued for liabilities for this product.
OptiPlex™ Products
241. Dell’s warranty obligations during the Class Period for the OptiPlex™ products
were a significant issue. For business systems, including OptiPlex™, Dell offered a standard
three-year warranty with on-site service, increasing the likelihood it would incur significant
costs. The OptiPlex GX270 systems in question (both the GX270 and GX280 desktops were
later disclosed to have the problem with the motherboard) were introduced in 5/03, with Dell
representing that the systems, which came with “a three-year next-business-day onsite service,”
are
designed for networked business environments, with long product lifecycles, standards-based technology and a full suite of user-friendly management tools, making them easy to deploy and maintain.
242. In the same press release on 5/21/03, Dell said the following about the systems:
Also new to the OptiPlex line is the availability of Serial ATA disk drives, which offer faster data transfer rates than Parallel ATA drives and employ smaller cables, improving airflow within the chassis.
“These two new systems provide more balance between performance and being able to set more aggressive goals for reductions in power consumption,” said Tim Mattox, vice president of Client Product Marketing for Dell. “These two products offer stability, strong management features and outstanding price/performance for enterprise customers.”
The GX270 and SX270 qualified for the ENERGY STAR(R) designation due in large part to its support of S3 “sleep state,” which suspends a user’s session to RAM after a preset time and consumes less than 15 watts of power while activated. When these systems are S3-enabled, they can help customers reduce energy costs by up to $175 per system over 3 years when compared to the same systems operated in screen saver mode. If all of Dell’s U.S. GX270 and SX270 customers operated in S3 mode for one year, enough energy could be saved to power an estimated 90,000 homes.
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243. The combination of Dell’s representations about the stability and performance of
the OptiPlex products with its three-year standard warranty increased the likelihood that if there
were any problems at all with the systems that customers would be both disappointed with the
product and both likely and entitled to require Dell to fix the problems.
244. GAAP, as set forth in SFAS No. 5, ¶¶24-25, states the following with respect to
warranties:
24. A warranty is an obligation incurred in connection with the sale of goods or services that may require further performance by the seller after the sale has taken place. . . . Losses from warranty obligations shall be accrued when the conditions in paragraph 8 are met. Those conditions may be considered in relation to individual sales with warranties or in relation to groups of similar types of sales made with warranties. If the conditions are met, accrual shall be made even though the particular parties that will make claims under warranties may not be identifiable.
25. If, based on available information, it is probable that customers will make claims under warranties relating to goods or services that have been sold, the condition in paragraph 8(a) is met at the date of an enterprise’s financial statements because it is probable that a liability has been incurred. Satisfaction of the condition in paragraph 8(b) will normally depend on the experience of an enterprise or other information.
245. In fact, the motherboards in the OptiPlex GX270 and GX280 business desktop
computers had capacitors which bulged and failed and would cause the PCs not to boot. The
system boards in question were manufactured from 4/03 to 3/04. At issue were faulty capacitors
on motherboards that store power and regulate voltage. Defective capacitors found in the Dell
OptiPlex workstations and PCs with the Intel D865GBF motherboard have been found to bulge,
pop, leak and crust over, causing video failure and periodic system shutdowns. The solution to
this problem was to replace the motherboard – a time-consuming process. The capacitors are
relatively inexpensive but replacing the whole motherboard on numerous PCs was very
expensive. Thus, if there were any problems with the product, the likelihood of claims was high
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and the cost of correcting the problem was significant – both factors that should have increased
Dell’s accruals for this contingency.
246. Dell knew long before the 3rdQ F05 that it had problems with the OptiPlex
GX270 and GX280. In 11/04, Dell China confirmed problems with the GX280 PC. Computer
repair shops noticed frequent “blue screens of death” and various programs that crashed on the
systems in 1/05. By 2/05, Dell was replacing all the motherboards with no questions asked.
247. Belatedly, in the 3rdQ F05, Dell recorded a $307 million charge to reflect the
costs to service OptiPlex™ systems, including a vendor part that failed to perform to
specification. This was a huge charge, reducing Dell’s gross profit in the quarter ended 10/28/05
to 16.18%, from its reported rate in most quarters of the Class Period of 17.8% to 18.5%. Note
the following chart which shows Dell’s gross margin, including the OptiPlex write-off and the
most recent quarter where gross margin fell to 15.54% due to the elimination of the rebates from
Intel, described below, and due to Dell having to cut prices dramatically to make up for lost sales
due to service and product problems:
Dell, Inc - Gross Margin
17.97%18.04%
17.47%17.58%17.57%
17.25%
17.91%
18.18%18.29% 18.34%
18.18%18.22%18.16%17.96%
18.23%
18.50%18.54%18.61%18.61%
16.18%
17.84%
17.39%
15.54%
14.00%
14.50%
15.00%
15.50%
16.00%
16.50%
17.00%
17.50%
18.00%
18.50%
19.00%
Feb-01
Apr-01
Jun-0
1
Aug-01
Oct-01
Dec-01
Feb-02
Apr-02
Jun-0
2
Aug-02
Oct-02
Dec-02
Feb-03
Apr-03
Jun-0
3
Aug-03
Oct-03
Dec-03
Feb-04
Apr-04
Jun-0
4
Aug-04
Oct-04
Dec-04
Feb-05
Apr-05
Jun-0
5
Aug-05
Oct-05
Dec-05
Feb-06
Apr-06
Jun-0
6
Aug-06
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248. Had Dell properly accrued for warranty expenses it knew it would incur for the
OptiPlex™ problems in a timely fashion, its gross margin and earnings in the last part of 2004
and first half of 2005 would have been materially lower than the amounts Dell reported.
249. That Dell was understating its reserve for warranty costs is demonstrated by the
relationship of actual cash warranty costs to the warranty reserve. In 1stQ F04, the warranty cost
as a percentage of warranty reserve was about 30% (comparable to Hewlett-Packard and just
above EMC). However, by end of F04 and early F05, the ratio increased to above 40% and has
stayed there since. At the same time, Hewlett-Packard’s and EMC’s respective ratios have
declined. This is an indication that Dell was under-reserving for warranty costs. These
increasing costs also indicate deteriorating product quality. The decreasing reserve came in the
face of Dell switching its basic warranty on consumer PCs from 90 days to one year in mid F05,
which would increase the liability.
250. Dell was also required to recognize extended warranty revenue over the term of
the warranty. FASB Technical Bulletin (“FTB”) No. 90-1, Accounting for Separately Priced
Extended Warranty and Product Maintenance Contracts, states in part:
Like short-duration insurance contracts, extended warranty and product maintenance contracts provide coverage against the risk of certain specified claim costs for a specified period. Those claim costs may take the form of repair costs if the product requires repair or service costs if the customer requests that a covered service be performed on the product. Paragraph 13 of Statement 60 indicates that premiums from short-duration insurance contracts should be recognized as revenue over the period of the contract in proportion to the amount of insurance protection provided. This Technical Bulletin concludes that revenue on extended warranty and product maintenance contracts also should be recognized in income evenly over the contract period except for those circumstances in which sufficient historical evidence indicates that costs of providing services under the contract are incurred in some pattern other than straight line.
FTB 90-1, ¶9.
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251. Dell represented that it did so. In its F06 Form 10-K, Dell stated:
Revenue from extended warranty and service contracts, for which Dell is obligated to perform, is recorded as deferred revenue and subsequently recognized over the term of the contract or when the service is completed.
252. Because Dell combined the accounting for basic and extended warranties in one
number, it obscured the under-accrual of warranty costs and the over-recognition of warranty
income from the sale of extended warranties. Both manipulations caused Dell’s income to be
overstated.
Dell Failed to Make Required Disclosures About the Existence, Impact and Uncertainty of Intel Rebates
253. It has now been documented extensively that over the past several years, in an
effort to maintain its market share, Intel has paid rebates to computer manufacturers on a
retroactive basis. Note how Fortune explained the rebates:
Suppose XYZ computer maker needs 100 chips per quarter, and that during the last quarter it bought 90 from Intel and ten from AMD. Since AMD wants to grow, it might bid for 20 of XYZ’s 100 units in the new quarter. . . .
Here’s how Intel allegedly dashes AMD’s hopes for gradual growth. It tells XYZ that its price per processor is, say, $90, but that if XYZ ends up buying more than 80% of its processors from Intel that quarter, it will pay a rebate of $10 per processor, resulting in an $80 price. The rebate, however, applies not just to the processors that put XYZ over the 80% target, but to every Intel processor XYZ purchases that quarter, back to the first one. That offer knocks AMD out of the box. [AMD] [o]utside counsel [Charles] Diamond explains why: “Effectively, what Intel’s saying is, If you don’t buy those ten incremental units from AMD, we’ll give you them for free.” That’s because 80 processors at $90 each cost the same as 90 processors at $80 each.”
(Emphasis in original.)
254. As either the top seller of personal computers (or close to it at all times during the
Class Period), Dell was a top recipient of Intel’s rebates. These rebates were significant to Dell’s
reported financial results. Even much smaller computer makers received significant rebates,
with Toshiba, for example, receiving $100 million per year. Dell’s rebates, given its size, were
approximately $1 billion per year. These rebates (internally called “e-CAP dollars”) were the
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equivalent to more than 2% points of gross margin or 10% of gross profit. Given Dell’s tax rate
for financial reporting purposes, the rebate added approximately 20% to net income and EPS
each quarter as well.
255. Given the significance of the rebates to Dell’s reported financial results, the
rebates were required by GAAP and SEC rules to be disclosed. Internally at Dell these rebates
were significant enough to merit a separate line item on certain internal Company reports. This
significance was even more the case given the rebates’ uncertain future. The rebates were:
(a) not guaranteed – Intel could stop them at any time or could reduce them
significantly without recourse by Dell;
(b) potentially illegal in that they could be stopped at any time by third
parties; and
(c) informal such that Dell would not be able to predict the amount and timing
and duration of the rebates.
256. Given the importance and uncertainty of the rebate practice, investors were denied
a full picture of Dell’s financial statements and the predictive value of the financial statements by
Dell’s concealment of the rebates. In fact, other vendors who received the rebates described (at
least at a cursory level) the rebates and the risk that the rebates could be eliminated. For
instance, Ingram Micro described the rebates as follows:
We receive purchase discounts and rebates from suppliers based on various factors, including sales or purchase volume and breadth of customers. These purchase discounts and rebates may affect gross margins. Many purchase discounts from suppliers are based on percentage increases in sales of products. Our operating results could be negatively impacted if these rebates or discounts are reduced or eliminated or if our vendors significantly increase the complexity of process and costs for us to receive such rebates.
Dell omitted any similar explanation from its filings.
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257. The SEC requires that, as to annual and interim financial statements filed with the
SEC, registrants include a management’s discussion and analysis section which provides
information with respect to the results of operations and “also shall provide such other
information that the registrant believes to be necessary to an understanding of its financial
condition, changes in financial condition and results of operations.” See Regulation S-K, 17
C.F.R. §229.303(a). Regulation S-K states that, as to annual results, the management’s
discussion and analysis section shall:
(3) Results of operations. (i) Describe any unusual or infrequent events or transactions or any significant economic changes that materially affected the amount of reported income from continuing operations and, in each case, indicate the extent to which income was so affected. In addition, describe any other significant components of revenues or expenses that, in the registrant’s judgment, should be described in order to understand the registrant’s results of operations.
(ii) Describe any known trends or uncertainties that have had or that the registrant reasonably expects will have a material favorable or unfavorable impact on net sales or revenues or income from continuing operations. If the registrant knows of events that will cause a material change in the relationship between costs and revenues (such as known future increases in costs of labor or materials or price increases or inventory adjustments), the change in the relationship shall be disclosed.
17 C.F.R. §229.303(a)(3)(i)-(ii).
258. The SEC also requires that interim period financial statements filed with the SEC
include a management’s discussion and analysis of the financial condition and results of
operations so as to enable the reader to assess material changes in financial condition and results
of operations. Regulation S-K, 17 C.F.R. §229.303(b), states that: “The discussion and analysis
shall include a discussion of material changes in those items specifically listed in paragraph (a)
of this Item [as set forth above], except that the impact of inflation and changing prices on
operations for interim periods need not be addressed.” As one court noted:
Item 303 (a)(3)(ii) essentially says to a registrant: If there has been an important change in your company’s business or environment that significantly or
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materially decreases the predictive value of your reported results, explain this change in the prospectus. The obvious focus is on preventing the latest reported results from misleading potential investors, thereby promoting a more accurate picture of the registrant’s future prospects.
See Oxford Asset Mgmt. v. Jaharis, 297 F.3d 1182, 1192 (11th Cir.2002).
259. During the Class Period, Dell failed to truthfully disclose the impact of Intel’s
rebates on its operating income and margins and that such rebates were discretionary by Intel and
could be eliminated at any time. After Dell announced its disastrous 2ndQ F07 results, Rollins
refused to comment on the Intel subsidies, but analysts understood cut-off of these subsidies to
be a “large chunk of the margin miss.” See Merrill Lynch report dated 8/18/06. Yet Dell had
concealed in its prior SEC filings the significance of the Intel subsidies.
260. Moreover, GAAP requires that financial information be useful to potential
investors and creditors. GAAP, as described by Concepts No. 1, ¶37, states:
Financial reporting should provide information to help present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans . . . . Thus, financial reporting should provide information to help investors, creditors, and others assess the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise.
261. The rebates Intel paid to Dell were exactly the type of information that was
important to investors in assessing cash inflows to Dell. However, defendants omitted this
information from Dell’s disclosures. In fact, while including risk disclosures about its
relationship with Intel as a significant supplier, it failed to disclose this material part of the
relationship. The disclosures about Intel, including for example these from Dell’s Form 10-Ks,
omitted the rebate issue:
• F05 Form 10-K: “Dell currently relies on Intel Corporation as a sole source supplier of processors and Microsoft Corporation as a sole source for various operating system and application software products. These relationships and dependencies have not caused material disruptions in the past, and Dell believes
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that any disruptions that may occur would not disproportionately disadvantage Dell relative to its competitors.”
• F04 Form 10-K: “Dell’s reliance on suppliers creates risks and uncertainties. Dell’s manufacturing process requires a high volume of quality components that are procured from third-party suppliers. Reliance on suppliers, as well as industry supply conditions, generally involves several risks, including the possibility of defective parts (which can adversely affect the reliability and reputation of Dell’s products), a shortage of components and reduced control over delivery schedules (which can adversely affect Dell’s manufacturing efficiencies), and increases in component costs (which can adversely affect Dell’s profitability).”
262. None of these disclosures even hinted at the possibility that Dell was receiving
rebates that were materially improving Dell’s reported financial results. As a result, investors
were left with a misleading portrayal of Dell’s financial performance. The impact of the market
becoming aware of these rebates was significant. As the issue came to the forefront beginning in
the spring of 2006, analysts’ forecasts for Dell’s future gross margins dropped dramatically.
Note the following chart showing Merrill Lynch’s forecasts for Dell’s F07 and F08 gross margin:
Dell, Inc. - Forecasted Gross Margin
15.00%
15.50%
16.00%
16.50%
17.00%
17.50%
18.00%
18.50%
19.00%
10/10/2005 2/17/2006 5/19/2006 8/18/2006
Date of Merrill Lynch Forecast
2007 Gross Margin 2008 Gross Margin
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The SEC and DOJ Investigations into Dell’s Accounting May Lead to a Restatement of Dell’s Past Financial Statements – an Admission that Those Financial Statements Were False
263. Dell has now acknowledged that the SEC and U.S. Attorney are investigating its
past financial statements. On 9/11/06, Dell filed a Form 8-K:
Dell Inc. announced today that it is delaying the filing of the Form 10-Q for its fiscal second quarter ended August 4, 2006.
The company said it is unable to file because of questions raised in connection with the previously announced informal investigation by the U.S. Securities and Exchange Commission (SEC) into certain accounting and financial reporting matters and the subsequently initiated independent investigation by the Audit Committee of its board of directors. The company said it plans to file the report as soon as possible.
The investigations have indicated the possibility of misstatements in prior period financial reports, including issues relating to accruals, reserves and other balance sheet items that may affect the company’s previously reported financial results. The company is working with the Audit Committee and with the company’s independent auditors to determine if any restatements of prior period financial reports will be necessary. “We have not yet reached any conclusion on materiality as to these issues,” said Don Carty, chairman of the Audit Committee reviewing the matter. “We are continuing to investigate the matter fully,” Carty added.
The SEC requests for information have been joined by a similar request from the United States Attorney for the Southern District of New York, who has subpoenaed documents related to the company’s financial reporting from 2002 to the present.
264. The fact that Dell has mentioned “restatement” of its past financial statements is
significant. The restatement of its financial statements would be an admission that:
(a) The financial results originally issued during the Class Period and public
statements regarding those results were materially false and misleading;
(b) The financial statements reported during the Class Period were incorrect
based on information available to defendants at the time the results were originally reported; and
(c) The financial statements should no longer be relied upon as being
accurate.
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265. The SEC has reiterated its position regarding restatements:
[T]he Commission often seeks to enter into evidence restated financial statements, and the documentation behind those restatements, in its securities fraud enforcement actions in order, inter alia, to prove the falsity and materiality of the original financial statements [and] to demonstrate that persons responsible for the original misstatements acted with scienter . . . .
In re Sunbeam Sec. Litig., No. 98-8258-Civ.-Middlebrooks, Brief of the United States Securities
and Exchange Commission as Amicus Curiae Regarding Defendants’ Motions In Limine to
Exclude Evidence of the Restatement and Restatement Report at 2 (S.D. Fla. Jan. 31, 2002).
266. The fact that Dell may restate its past financial statements would be an admission
that the financial statements originally issued were false and that the overstatement of net income
was material. Pursuant to GAAP, as set forth in Accounting Principles Board Opinion (“APB”)
No. 20, the type of restatement anticipated for Dell would be to correct for material errors in its
previously issued financial statements. See APB No. 20, ¶¶7-13. Moreover, SFAS No. 154, ¶25,
Accounting Changes and Error Corrections” states: “Any error in the financial statements of a
prior period discovered subsequent to their issuance shall be reported as a prior-period
adjustment by restating the prior-period financial statements.” Thus, GAAP provides that
financial statements should be restated in order to correct an error in previously issued financial
statements. Dell’s restatement would be due to error.
267. Due to these accounting improprieties, the Company presented its financial results
and statements in a manner which violated GAAP, including the following fundamental
accounting principles:
(a) The principle that financial reporting should provide information about
how management of an enterprise has discharged its stewardship responsibility to owners
(stockholders) for the use of enterprise resources entrusted to it was violated. To the extent that
management offers securities of the enterprise to the public, it voluntarily accepts wider
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responsibilities for accountability to prospective investors and to the public in general (Concepts
No. 1, ¶50);
(b) The principle that financial reporting should provide information about an
enterprise’s financial performance during a period was violated. Investors and creditors often
use information about the past to help in assessing the prospects of an enterprise. Thus, although
investment and credit decisions reflect investors’ expectations about future enterprise
performance, those expectations are commonly based at least partly on evaluations of past
enterprise performance (Concepts No. 1, ¶42);
(c) The principle that financial reporting should be reliable in that it
represents what it purports to represent was violated. That information should be reliable as well
as relevant is a notion that is central to accounting (Concepts No. 2, ¶¶58-59);
(d) The principle of completeness, which means that nothing is left out of the
information that may be necessary to insure that it validly represents underlying events and
conditions was violated (Concepts No. 2, ¶79); and
(e) The principle that conservatism be used as a prudent reaction to
uncertainty to try to ensure that uncertainties and risks inherent in business situations are
adequately considered was violated. The best way to avoid injury to investors is to try to ensure
that what is reported represents what it purports to represent (Concepts No. 2, ¶¶95, 97).
268. Further, the undisclosed adverse information concealed by defendants during the
Class Period is the type of information which, because of SEC regulations, regulations of the
national stock exchanges and customary business practice, is expected by investors and securities
analysts to be disclosed and is known by corporate officials and their legal and financial advisors
to be the type of information which is expected to be and must be disclosed.
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DELL’S FALSE SARBANES-OXLEY CERTIFICATIONS IN ITS SEC FILINGS
269. Throughout the Class Period, Dell’s SEC 10-K and 10-Q filings contained
Sarbanes-Oxley certifications. The language of these certifications were identical – with only
the signatures and filing date changed. The 10-Q certifications stated:
Controls and Procedures
Under the supervision and with the participation of Dell’s management, including Dell’s Chief Executive Officer and Chief Financial Officer, Dell has evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934) within 90 days prior to the date of this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective in enabling Dell to record, process, summarize and report information required to be included in Dell’s periodic SEC filings within the required time period. Additionally, there have been no significant changes in Dell’s internal controls or in other factors that could significantly affect internal controls subsequent to the date that Dell completed its evaluation.
CERTIFICATION OF MICHAEL S. DELL, CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER, PURSUANT TO RULE 13a-14
OF THE SECURITIES EXCHANGE ACT OF 1934
I, [Michael S. Dell or Kevin Rollins], certify that:
1. I have reviewed this quarterly [or annual] report on Form 10-Q [or 10-K] of Dell Computer Corporation;
2. Based on my knowledge, this quarterly [or annual] report does not contain any untrue statement of a material fact or omit to state a material fact in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly [or annual] report;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly [or annual] report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly [or annual] report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rule 13a-14 and 15c-14) for the registrant and we have:
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a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly [or annual] report is being prepared;
b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly [or annual] report (the “Evaluation Date”); and
c) presented in this quarterly [or annual] report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of this Evaluation Date;
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function);
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6. The registrant’s other certifying officers and I have indicated in this quarterly [or annual] report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
[Date] [Signed – Chairman/CEO]
CERTIFICATION OF JAMES M. SCHNEIDER, SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER,
PURSUANT TO RULE 13a-14 OF THE SECURITIES EXCHANGE ACT OF 1934
I, James M. Schneider, certify that:
1. I have reviewed this quarterly [or annual] report on Form 10-Q [or 10-K] of Dell Computer Corporation;
2. Based on my knowledge, this quarterly [or annual] report does not contain any untrue statement of a material fact or omit to state a material fact in order to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly [or annual] report;
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3. Based on my knowledge, the financial statements, and other financial information included in this quarterly [or annual] report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly [or annual] report;
4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rule 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly [or annual] report is being prepared;
b) evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly [or annual] report (the “Evaluation Date”); and
c) presented in this quarterly [or annual] report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of this Evaluation Date;
5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function);
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
6. The registrant’s other certifying officers and I have indicated in this quarterly [or annual] report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
[Date] [Signed – CFO]
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CERTIFICATION OF . . . AND CHIEF EXECUTIVE OFFICER, AND JAMES M. SCHNEIDER, SENIOR VICE
PRESIDENT AND CHIEF FINANCIAL OFFICER, PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT
TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, [Michael S. Dell or Kevin Rollins], Chief Executive Officer of Dell Computer Corporation (the “Company”), hereby certify that (a) the Company’s Quarterly [or Annual] Report on Form 10-Q [or 10-K] for the quarter [or year] ended [date], as filed with the Securities and Exchange Commission (the “Report”), fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934, and (b) information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
[Date] [Signed – Chairman/CEO]
I, James M. Schneider, Senior Vice President and Chief Financial Officer of Dell Computer Corporation (the “Company”), hereby certify that (a) the Company’s Quarterly [or Annual] Report on Form 10-Q [or 10-K] for the quarter [or year] ended [date], as filed with the Securities and Exchange Commission (the “Report”), fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934, and (b) information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
[Date] [Signed – CFO]
270. The Form 10-K certifications also stated:
• 2004:
The management of Dell, with the participation of Dell’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of Dell’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this Report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that Dell’s disclosure controls and procedures are effective in enabling Dell to record, process, summarize, and report information required to be included in Dell’s periodic SEC filings within the required time period.
In addition, the management of Dell, with the participation of Dell’s Chief Executive Officer and Chief Financial Officer, has evaluated whether any change in Dell’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) occurred during Dell’s fourth fiscal quarter. Based on that evaluation, Dell’s Chief Executive Officer and Chief Financial Officer have concluded that there has been no change in Dell’s internal control over financial reporting during the fourth fiscal quarter that has materially
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affected, or is reasonably likely to materially affect, Dell’s internal control over financial reporting.
• 2005:
Evaluation of Disclosure Controls and Procedures – Dell’s Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of Dell’s disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Exchange Act) as of the end of the period covered by this report, have concluded that, based on the evaluation of these controls and procedures, Dell’s disclosure controls and procedures were effective.
Management’s Report on Internal Control Over Financial Reporting – Dell’s management, under the supervision of Dell’s Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) or 15d-15(f) under the Exchange Act). Management evaluated the effectiveness of Dell’s internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, management has concluded that Dell’s internal control over financial reporting was effective as of [relevant date].
* * *
Changes in Internal Control Over Financial Reporting – Dell’s management, with the participation of Dell’s Chief Executive Officer and Chief Financial Officer, has evaluated whether any change in Dell’s internal control over financial reporting occurred during the fourth quarter of fiscal [date]. Based on that evaluation, management concluded that there has been no change in Dell’s internal control over financial reporting during the fourth quarter of fiscal [date] that has materially affected, or is reasonably likely to materially affect, Dell’s internal control over financial reporting.
271. The certifications were filed with the following 10-Q and 10-K Reports on or
about the date stated, signed by the defendant indicated:
PERIODIC REPORT M. DELL ROLLINS SCHNEIDER
2003 10K 4/25/03 4/25/03 1Q 04 6/16/03 6/16/03 2Q 04 9/15/03 9/15/03 3Q 04 12/15/03 12/15/03
2004 10K 4/12/04 4/12/04 1Q 05 6/9/04 6/9/04 2Q 05 9/7/04 9/7/04 3Q 05 12/1/04 12/1/04
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2005 10K 3/7/05 3/7/05 1Q 06 6/3/05 6/3/05 2Q 06 9/1/05 9/1/05 3Q 06 11/28/05 11/28/05
2006 10K 3/15/06 3/15/06 1Q 07 6/7/06 6/7/06
272. Each of the Sarbanes-Oxley certifications filed in Dell’s quarterly and annual
SEC reports was false and misleading. Dell’s financial controls were not adequate to assure
compliance with SEC reporting regulations, principles of fair reporting or GAAP. Specifically,
the controls were inadequate to assure proper recognition of revenue, proper recognition and
accrual of warranty costs and product repair costs and proper presentation of the true nature and
impact of the secret Intel rebates/kickbacks which were so material to Dell’s quarterly operating
profits and operating profit margins. In addition, Dell’s internal disclosure controls were
inadequate because they were not preventing Dell from making false and misleading statements
about its business and finances as detailed in this Complaint, including failure to disclose the
highly material Intel rebates/kickbacks upon which Dell’s superior financial performance
actually depended and without which Dell’s future financial performance would be much worse
than that being forecast. Finally, the Sarbanes-Oxley certifications were false and misleading
because material fraud existed within Dell vis-à-vis its SEC filings and public disclosures,
including an override by its top executives, i.e., M. Dell, Rollins and Schneider, of the systems
that were, in fact, in place at Dell regarding compliance with SEC rules, regulations and GAAP
accounting.
273. These 10-K and 10-Q certifications were material to investors. After the upsurge
of fraud in public companies in 2000-2002, Congressional investigations showed that in most
cases these financial frauds occurred, in part, because of weak internal or disclosure controls and
inevitably involved the CEO and CFO of the company. The Sarbanes-Oxley procedures and the
certifications representing that those procedures had been followed and were effective are meant
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to provide significant assurance to investors that the issuer and executives involved are acting
honestly and not engaged in making false statements, inadequate disclosures or financial
falsifications. Investors rely on these representations and they are reflected in the price of the
issuer’s stock.
PRICEWATERHOUSECOOPERS’ LIABILITY
274. PWC’s Austin office was engaged to examine and report on Dell’s financial
statements for F03-F06, to perform review services on Dell’s interim F03-F06 results, and to
provide consulting, tax and other services related to Dell’s SEC filings, including comfort letters,
consents and comment letters. PWC, or its predecessor, has been Dell’s auditor since 1986.
PWC further audited Dell’s internal controls over financial reporting for F05 and F06 and issued
reports on those audits. PWC’s unqualified reports on Dell’s financial statements and internal
controls were included in Dell’s SEC filings. As a result of the far-reaching scope of services
provided by PWC and its long-term engagement by Dell, PWC personnel were intimately
familiar with Dell’s business, including Dell’s accounting for its rebates from Intel and its
reserves for warranty liabilities.
275. PWC participated in the wrongdoing alleged herein in order to retain Dell as a
client and to protect the fees it expected to receive from Dell. PWC enjoyed a lucrative business
relationship with Dell’s senior management for which it has received millions of dollars in fees
for auditing, internal control work, consulting and tax services. PWC’s work for Dell included
special engagements such as verifying the number of employees in certain municipalities so Dell
could receive subsidies per employee in those municipalities. PWC received $11.3 million and
$10.9 million in fees from Dell in F06 and F05, respectively. These fees were particularly
important to the partners in PWC’s Austin office, as their incomes were dependent on the
continued business from Dell.
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PWC’s False Statements as to Dell’s Financial Statements
276. PWC falsely represented that Dell’s financial statements for F03 were presented
in accordance with GAAP and that for F03-F04 PWC’s audits of Dell’s financial statements had
been performed in accordance with GAAS. For F05-F06, PWC represented it had completed an
integrated audit of Dell’s financial statements and internal controls in accordance with standards
of the Public Company Accounting Oversight Board (“PCAOB”). PWC also consented to the
incorporation of its false reports on Dell’s financial statements in Dell’s Form 10-Ks for the
respective years of its audits, which were filed with the SEC. PWC’s issuance of materially false
reports on Dell’s F03-F06 financial statements was by itself a violation of GAAS and the
PCAOB.
277. The SEC has stressed the importance of meaningful audits being performed by
independent accountants:
[T]he capital formation process depends in large part on the confidence of investors in financial reporting. An investor’s willingness to commit his capital to an impersonal market is dependent on the availability of accurate, material and timely information regarding the corporations in which he has invested or proposes to invest. The quality of information disseminated in the securities markets and the continuing conviction of individual investors that such information is reliable are thus key to the formation and effective allocation of capital. Accordingly, the audit function must be meaningfully performed and the accountants’ independence not compromised.
Relationships Between Registrants and Independent Accountants, SEC Accounting Series
Release No. 2961, 1981 SEC LEXIS 858, at *8-*9 (Aug. 20, 1981).
278. GAAS, as approved and adopted by the American Institute of Certified Public
Accountants (“AICPA”), relate to the conduct of individual audit engagements. Statements on
Auditing Standards (codified and referred to as AU §__) are recognized by the AICPA as the
interpretation of GAAS. Subject to SEC oversight, §103 of the Sarbanes-Oxley Act authorizes
the PCAOB to establish auditing and related attestation, quality control, ethics, and
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independence standards to be used by registered public accounting firms in the preparation and
issuance of audit reports as required by the Act or the rules of the Commission. Accordingly,
public accounting firms registered with the PCAOB are required to adhere to all PCAOB
Standards in the audits of the financial statements of issuers, as defined by the Act, and other
entities when prescribed by the rules of the Commission.
279. With respect to Dell’s financial statements for the fiscal year ended 1/30/04,
PWC represented, in a report dated 2/12/04 included in the Company’s 2004 10-K, the
following:
To the Board of Directors and Stockholders of Dell Inc.
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Dell Inc. and its subsidiaries at January 30, 2004 and January 31, 2003, and the results of their operations and their cash flows for each of the three fiscal years in the period ended January 30, 2004, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index, presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of Dell’s management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, during fiscal 2004 Dell changed its method of accounting to consolidate the results of Dell Financial Services L.P., an existing joint venture.
PRICEWATERHOUSECOOPERS LLP
280. PWC issued a nearly identical report as to Dell’s F03 financial statements.
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281. With respect to Dell’s F05 financial statements, PWC represented in a report
dated 3/3/05, the following:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of Dell Inc.
We have completed an integrated audit of Dell Inc.’s January 28, 2005 consolidated financial statements and of its internal control over financial reporting as of January 28, 2005 and audits of its January 30, 2004 and January 31, 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated Financial Statements and Financial Statement Schedule
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Dell Inc. and its subsidiaries at January 28, 2005 and January 30, 2004, and the results of their operations and their cash flows for each of the three years in the period ended January 28, 2005 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
Internal Control Over Financial Reporting
Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A – Controls and Procedures, that the company maintained effective internal control over financial reporting as of January 28, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our
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opinion, the company maintained, in all material respects, effective internal control over financial reporting as of January 28, 2005, based on criteria established in Internal Control – Integrated Framework issued by the COSO. The company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
PRICEWATERHOUSECOOPERS LLP
282. PWC also signed off on and approved Dell’s quarterly financial results prior to
their issuance to the public during the Class Period. According to Dell’s 2006 Proxy Statement
filed on 7/21/06, the audit fees billed by PWC in connection with F05 and F06 were for the
audits of the consolidated financial statements and audit of internal controls under §404 of
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Sarbanes-Oxley. PWC also received fees for audits of Dell’s employee benefit plans and
contract compliance work and timely quarterly reviews. PWC also was paid for tax work,
including tax consulting for Dell executives.
283. PWC’s reports were false and misleading due to its failure to comply with GAAS
and PCAOB rules and because Dell’s financial statements were not prepared in conformity with
GAAP, as alleged above, so that issuing the reports was in violation of GAAS and SEC rules.
PWC knew its reports would be relied upon by the Company as well as by present and potential
investors in Dell’s stock.
PWC Ignored the Audit Evidence It Gathered
284. GAAS, as set forth in AU §326, Evidential Matter, requires auditors to obtain
sufficient competent evidential matter through inspection, observation, inquiries and
confirmations to afford a reasonable basis for an opinion regarding the financial statements under
audit:
In evaluating evidential matter, the auditor considers whether specific audit objectives have been achieved. The independent auditor should be thorough in his or her search for evidential matter and unbiased in its evaluation. In designing audit procedures to obtain competent evidential matter, he or she should recognize the possibility that the financial statements may not be fairly presented in conformity with generally accepted accounting principles or a comprehensive basis of accounting other than generally accepted accounting principles. In developing his or her opinion, the auditor should consider relevant evidential matter regardless of whether it appears to corroborate or to contradict the assertions in the financial statements. To the extent the auditor remains in substantial doubt about any assertion of material significance, he or she must refrain from forming an opinion until he or she has obtained sufficient competent evidential matter to remove such substantial doubt, or the auditor must express a qualified opinion or a disclaimer of opinion.
AU §326.25 (footnotes omitted). The PCAOB adopted this same standard.
285. PWC’s responsibility, as Dell’s independent auditor, was to obtain “[s]ufficient
competent evidential matter . . . to afford a reasonable basis for an opinion regarding the
financial statements under audit” as to “the fairness with which they present, in all material
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respects, financial position, results of operations, and its cash flows in conformity with generally
accepted accounting principles.” AU §§150, 110.
286. In violation of GAAS and PCAOB rules, and contrary to the representations in its
report on Dell’s financial statements, PWC did not obtain sufficient, competent, evidential matter
to support Dell’s assertions regarding its accounting for its loss reserves.
PWC Failed to Design Its Audit to Identify the Alleged Improprieties
287. As one of the largest audit firms in the world, PWC was well aware of the
strategies, methods and procedures required by GAAS to conduct a proper audit. Also, PWC
knew of the audit risks inherent at Dell and in the industries in which Dell operated because of
the comprehensive services it provided to Dell and its experience with many other clients in the
computer industry. PWC was also the auditor for IBM and Cisco. In fact, on PWC’s Web site,
it emphasizes its expertise in providing assurance services with respect to complete and accurate
financial statements:
Financial Statement Audit
The financial statement audit has never been more important. In today’s business environment there is more scrutiny and skepticism of a company’s financial statements than ever before. Investors have lost faith in corporate governance and reporting and they expect more: greater reliability, more oversight and clear evidence of internal controls. Corporate management, boards and audit committees, internal and external auditors, analysts and other investment professionals all have important roles to play in rebuilding investor trust by executing their respective responsibilities, keeping in mind both legal obligations and the heightened expectations of investors. Meeting investor expectations begins with the completeness and accuracy of information contained in a company’s financial statements.
* * *
How . . . PwC can help you
For organisations that require an audit for statutory or regulatory reasons associated with the filing of their annual and periodic financial information, PwC can provide high quality audit services. We can also address any specific regulatory reporting requirements such as those under Sarbanes-Oxley S404 for SEC registrants, including foreign private issuers.
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PwC’s work takes into account all current and where appropriate, prospective auditing, accounting, and reporting regulations and guidance. Our audit clients include many of the world’s leading multinational corporations, as well as many small and medium-sized companies and a significant number of local authorities and other public sector bodies.
• Compliance with regulations • Advice on controls and processing system weaknesses • Confirmation of accounting treatments with respect to complex
transactions • Increased monitoring of prospective accounting and regulatory
changes • Independent review of externally reported information • Accountants’ reports
288. PWC’s Web site also represented PWC had special expertise in assisting
companies with internal controls:
How PwC can help you
Our Systems and Process Assurance (SPA) practice provides services related to controls around the financial reporting process, including financial business process and IT management controls. Serving both audit and non-audit clients, SPA provides:
• Financial and operation applications/business process controls reviews
• Database security controls reviews • IT general controls reviews • Infrastructure security reviews • Third party assurance and opinion services • Sarbanes-Oxley readiness, process improvement and sustainability
services • Compliance with other regulatory requirements (e.g., Turnbull,
Basel II, King) • Due diligence on systems and controls • Pre- and post-implementation systems reviews • Project assurance services • Data services (e.g., CAATs, data quality reviews) • Computer security reviews
289. In connection with Dell’s operations, PWC had virtually limitless access to
information concerning the Company’s true operations as:
• PWC had been Dell’s auditor since 1986.
• PWC was present at Dell’s headquarters and divisions frequently during the Class Period.
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• PWC provided Dell with substantial internal control services to Dell.
• PWC had frequent conversations with Dell management and employees about the Company’s operations and financial statements.
• PWC audited and reviewed Dell’s financial statements during the Class Period and knew or should have known that Dell’s financial statements were not accurate or prepared in compliance with GAAP or GAAS or PCAOB standards.
• PWC knew that Intel was Dell’s biggest supplier and that any rebates from Intel were significant to Dell’s bottom line. This rebate, approximately $1 billion annually, was shown on a separate line item on Dell’s internal financial statements for at least one of its divisions.
• PWC would have been included in discussions with the SEC about the SEC inquiry into Dell’s accounting. PWC knew this inquiry was not disclosed to Dell’s shareholders.
290. PWC’s intentional failure to comply with PCAOB and GAAS in its performance
on the Dell audits rose to the level of deliberate recklessness, as the following paragraphs
demonstrate. PWC abandoned its role as independent auditor by turning a blind eye to each of
the above indications of improper accounting, including Dell’s accounting for warranty
expenses. Despite this knowledge, PWC did not insist upon adjustments to Dell’s audited
financial statements. Pursuant to GAAS, PWC should have issued a qualified or adverse report,
or it should have insisted that Dell comply with GAAP.
291. As to its audits of Dell during the Class Period, PWC was required to perform its
audit in conformity with the Statement of Accounting Standard (“SAS”) No. 82, Consideration
of Fraud in a Financial Statement Audit, which includes auditing for material misstatements
arising from fraud. PWC failed to comply with SAS No. 82 in its audit of Dell’s financial
statements. During the course of its audit of Dell’s financial statements during the Class Period,
PWC knew of or should have discovered the irregularities which caused Dell’s earnings to be
misstated. The very risk of fraud was a potential reportable condition which should have been
reported to the audit committee and possibly senior management.
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292. PWC’s failure to adequately perform its audit procedures to identify the
improprieties alleged herein and its failure to report the problems permitted the accounting
irregularities and improprieties to continue over a period of years, leading to false and misstated
financial statements. Moreover, PWC failed to adequately audit Dell’s internal controls which
were inadequate and permitted Dell’s misstatements to occur.
293. Despite PWC’s “clean” audit reports during the Class Period, Dell has recorded
$307 million in special charges related to its warranty liabilities. These charges did not relate to
recent events, but had been incurred in significant part much earlier in the Class Period.
Moreover, the SEC had begun an inquiry into Dell’s accounting and requested that the Company
produce documents and information.
294. The special charges and the SEC inquiry all involve periods during which Dell’s
financial results had been audited by PWC and for which PWC had issued unqualified reports.
PWC’s Audit Procedures Violated Fundamental Concepts of GAAS
295. PWC’s failure to adequately perform its audit procedures to identify the
improprieties alleged herein and its failure to report the problems permitted the accounting
irregularities and improprieties to continue over a period of at least a one year, leading to false
and misstated financial statements. Due to PWC’s false statements and failure to identify and
modify its reports to identify Dell’s false financial reporting, PWC violated the following
PCAOB and GAAS standards:
(a) The first general standard is that the audit should be performed by persons
having adequate technical training and proficiency as auditors;
(b) The second general standard is that the auditors should maintain an
independence in mental attitude in all matters relating to the engagement;
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(c) The third general standard is that due professional care is to be exercised
in the performance of the audit and preparation of the report;
(d) The first standard of field work is that the audit is to be adequately
planned and that assistants should be properly supervised;
(e) The second standard of field work is that the auditor should obtain a
sufficient understanding of internal controls so as to plan the audit and determine the nature,
timing and extent of tests to be performed;
(f) The third standard of field work is that sufficient, competent, evidential
matter is to be obtained to afford a reasonable basis for an opinion on the financial statements
under audit;
(g) The first standard of reporting is that the report state whether the financial
statements are presented in accordance with GAAP;
(h) The second standard of reporting is that the report shall identify
circumstances in which GAAP has not been consistently observed;
(i) The third standard of reporting is that informative disclosures are regarded
as reasonably adequate unless otherwise stated in the report; and
(j) The fourth standard of reporting is that the report shall contain an
expression of opinion or the reasons why an opinion cannot be expressed.
SCIENTER AND SCHEME ALLEGATIONS
296. During the Class Period, the defendants had both the motive and opportunity to
conduct fraud. They also had actual knowledge of the falsity of the statements they made or
acted in reckless disregard of the truth or falsity of those statements. In so doing, the defendants
participated in a scheme to defraud and committed acts, practices and participated in a course of
business that operated as a fraud or deceit on purchasers of Dell stock during the Class Period.
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297. The Dell Defendants’ massive insider selling raises a strong inference of
knowledge or fraud by each selling defendant as the selling of each was unusual in timing and
amount.
298. Dell curtailed its own manufacturing quality and control programs to save money,
cutting back on inspections and testing of both component parts (including batteries) and
finished goods, i.e., PCs, knowingly or recklessly disregarding that this would exacerbate Dell’s
product quality problems. Dell did not independently test laptop computer parts manufactured
by third-party suppliers, including batteries, hard drives, optical drives (i.e., CD or DVD drives)
or motherboards. Instead, Dell’s suppliers conducted the testing. Dell did not test third-party
supplier (vendor) parts. Dell allowed the Company’s vendors to conduct parts testing. The
Company took the vendor’s word for it where part quality was concerned. Dell only checked the
functionality of the particular part. For example, when Dell purchased laptop batteries from
Sony, upon receipt of the parts, Dell only placed the batteries in the laptops to make sure that
they provided a power source (i.e., allowed the laptop computer to turn on). This was why Dell
did not catch the defective Sony battery issues prior to shipment of the batteries to market. CEO
Rollins was very involved in the Company’s product quality issues, as Rollins handled
operational functions at the Company.
299. Producing high-quality laptops required testing of various parts, including hard
drives, floppy drives, optical drives (i.e., CD or DVD drives) motherboards and batteries.
Between 2002 and 2006, Dell’s average repeat return rates for all laptops were very “high” –
between 12% and 15%. A “good” return rate for a technology company was between four and
five percent and a 12% to 15% return rate was “bad.” The power adaptor used for a very large
number of laptops had a 30% repeat return rate in 2004 and 2005. A power adaptor plugs into
the back of notebooks and is used to recharge the notebook’s battery. The particular adaptor
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used in 2004 and 2005 supplied 19 volts to the notebook. Defective laptop products were on
most occasions returned directly to the suppliers. Dell suppliers conducted testing on the
returned laptops and then provided the Company with repeat return rate data (“Supplier Data”).
The Supplier Data included information regarding the number of returned notebooks tested, the
failure rates of same (i.e., information regarding customer-induced failures and failure of
replaceable (or “accessory”) parts, such as power adaptors, hard drives and motherboards).
Upon receipt of the return rates, Dell then attempted to determine the specific reasons why
customers were returning their notebooks multiple times, based on the Supplier Data.
300. Dell was encountering lithium battery problems due to supplier shortfalls and its
own manufacturing problems as early as 2001.
301. Notebook batteries were not independently tested by Dell prior to shipment. If a
Dell OEM (original equipment manufacturer) stated that a particular battery was compatible with
the specifications of the notebook it would be placed in, then Dell accepted this. Dell should
have been able to determine that the Sony batteries would explode if it had conducted the proper
battery compatibility testing. The only laptop battery “testing” that Dell did was either checking
to determine if batteries charged properly (and sometimes the Company did not even do this) or
placing the battery in the laptop to determine if it provided a power source (i.e., that the laptop
would turn on). Testing Department engineers hooked up laptop batteries to a machine to
determine if the batteries would charge from an eight to a nine on the “battery scale meter.” This
was not a good test capability for batteries.
302. In order to determine if the batteries within a particular lot (certain number of
batteries) were compatible with the notebook products in which they were to be placed, full
testing had to be done on the batteries. Full testing required testing of the battery’s current (or
wattage) and load capabilities (or rates) to make sure that such rates matched the notebook’s
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required rates in these areas. Special tools are required to do this testing and Dell did not have
these tools (and did not required its suppliers to conduct this testing). A battery’s load must be
tested to make sure that the battery can perform to the maximum current for which it is designed.
If this testing is not conducted, the batteries are likely to blow up because notebooks are
specifically designed to accept only certain wattage batteries. Deviating from this specification
results in over-heating, leading to explosion.
303. Dell did not conduct load or current testing on batteries. Only 30 or 40 minutes
were allotted for pre-shipment laptop testing, per laptop unit, at Dell and this was not enough
time to conduct battery testing, “burn in” the units or any other extensive testing. The Company
did not test batteries in order to cut costs. Full testing is very time consuming. Dell relied on the
fact that if a problem developed, the customer could return the laptop to a supplier and get a
replacement part.
304. The Sony laptop battery issue (i.e., the fact that these batteries were
exploding/catching on fire) surfaced in late 2005 and information about this issue was included
in customer service call center monthly reports based on customer complaints. There was also
notice of the problems via an official corporate e-mail that came from a senior executive at Dell.
305. Dell shipped finished computer products without conducting product testing for
accessory parts in order to rush products to market. It was the Test Engineering Department’s
responsibility to then catch the problems later, after Dell satisfied its financial numbers by
shipping a certain number of products within a particular time period, i.e., yearly or quarterly.
There was technology available to test certain products that Dell did not utilize and the failure to
use such testing benefited the Company by cutting costs and increasing the number of items
shipped. Dell relied on the fact that if there was a problem with accessory parts placed in
laptops, it was up to the customer to return the product to one of its suppliers and then obtain a
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free replacement part (i.e., a new battery or power adaptor to replace a defective battery or power
adaptor). The products would eventually be shipped back to Dell suppliers and would require
additional testing at that time to determine the specific cause of repeat return rates.
306. With respect to parts purchased by the buyers in the Custom Factory Integration
Group (“CFI”), quality engineers tested parts that went into the processor like a sound card, NIC
card (network card) or video graphic card as opposed to items attached to a system like speakers
or a keyboard. CFI did not test all the products purchased by buyers in the CFI Group. For
example, Dell purchased certain keyboards at the request of DaimlerChrysler. DaimlerChrysler
requested approximately 1,000 special keyboards. After the keyboards were sent out into the
field (delivered to the customer), the failure rate was high, over 50% to 80%. DaimlerChrysler
soon complained to Dell about the quality of the keyboards. Dell sought to return them to the
keyboard manufacturer, but the manufacturer refused to take them. The supplier argued that Dell
had “qualified” the keyboards by adding them to its systems and sending them out to the
customer (i.e., Dell approved the keyboards for use by shipping them to the customer). These
keyboards were not tested and thus the failure rate in the field was very high.
307. Dell’s third-party suppliers conducted parts testing for the computer server
component products that the particular supplier sold to Dell, prior to the assembly of those
products at Dell. Dell conducted only system-level server tests. This meant that a certain small
percentage of Dell servers were “pulled off the production assembly line” and that tests were
conducted on the systems used with the server to determine if they functioned. Suppliers
provided the external parts for servers, such as disc drives, processors and memory, and then
Dell assembled the servers at its assembly or manufacturing plant in Austin, Texas. In the
process of assembling the servers, Dell integrated (or hooked up) the external parts to the server,
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turned on these parts and tested them prior to shipment. This process was referred to at Dell as
system regression testing.
308. The Company had a lot of problems with server power supply parts purchased
from its suppliers, but the worst power supply part failure occurred in 9/04 or 10/04. A power
supply is the part in a server which connects to a power cord, that plugs into a power source in a
wall, and converts AC (or alternating current power) to DC power. Astec (a power supply
manufacturer) supplied power parts purchased by Dell in mid-2004 which were plagued with
“serious endemic failure.” There was a massive contamination that occurred during the printed
circuit board assembly (“PCA”) process. Printed circuit boards were located inside the power
supply part. Proper PCA required a two-step washing process which occurred during the initial
creation of the boards. First the printed circuit boards must be dipped into acid. Next, the circuit
boards must be dipped into distilled water. Astec failed to maintain proper quality control in
their PCA process and dipped the circuit boards into tap water instead of distilled water. Dell
recalled or ordered a stop-ship of server products with Astec power supply parts (also referred to
as a recall of the servers with faulty parts) after servers with faulty power supply parts had been
shipped to Dell customers for several months before the problem was discovered. Dell had
discovered the power supply part failure problem during its system regression testing process,
before customers began to complain about the problem. Yet, the server products were shipped
with faulty Astec power supplies for several months.
309. Server group employees presented information to the meeting attendees regarding
quality control metrics for Dell’s server products, which included information regarding product
IFIRs (initial failure incidents rates, which were measured from first shipment to 30 days) and
FIRs (failure incident rates, which were measured from 31 days on). Dell’s quality control
metrics also included information regarding customer shipment dates (measured by order date).
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Dell monitored server product failures/problems by server part (i.e., hard disc drive failures and
processor failures) and by final server (i.e., assembled or completed servers). There were also
presentations made at the meetings about the status of every Dell server product.
310. The Intel/Dell rebate/kickback scheme was negotiated and agreed to at the top
levels of the two companies and, because of the size of the quarterly rebates and their
tremendous importance to Dell in materially reducing operating expenses as a percentage of
revenues and increased operating profit margins, were known to all top Dell executives,
including the Dell Defendants.
311. Intel and Dell had an exclusive relationship and Dell received product rebates for
shipping only Intel-based products and not doing business with AMD, called e-CAP payments.
The definition of “e-CAP” is “exception to corporate average pricing.” e-CAPs at Dell typically
referred to the discounts that Intel gave on its microprocessor chips. Dell received the rebate
money from Intel at the end of each quarter. Dell accrued for the total amount of the rebate at
the end of the quarter, whether or not the Company physically received the money or not. By
2002, these e-CAP payments increased greatly as the Company’s sales increased dramatically
(including sales of Intel-based products) from 1996 until 2006. Dell received over $100 million
per quarter in such payments during the Class Period.
312. Intel’s Marketing Development Funds (“MDFs”) were different than the rebates
described above. Dell also received MDFs from Intel on a quarterly basis and was required to
spend these funds on the sales and marketing of Intel-based products. In contrast, the rebate
funds could be used in any way the Company chose. MDFs were required to be used for sales or
marketing purposes by the Company. The amount of MDFs paid to Dell were dependent on the
percentage of revenues earned by the supplier from Dell’s sales of the supplier’s products (i.e.,
Intel-based products).
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313. Dell received a lump sum of money at the end of every quarter for not shipping
AMD-based products. This was a separate “bucket” of money that Dell received, i.e., separate
from rebates. This was based on a side understanding. The amount of funds provided to Dell for
not shipping AMD-based products was paid on a quarterly basis. Senor executives at Dell often
spoke in great detail about the importance of receiving the funds from Dell for not shipping
AMD-based products during the weekly Server Group staff meetings. On a regular basis (at
least yearly), Dell developed AMD-based products and came “very close” to shipping these
products, i.e., the products were set to ship within a few months or possibly weeks; however,
Dell always decided not to ship the AMD products, due to the large sums of money the Company
would lose from Intel for breaching the exclusive Dell/Intel processor relationship.
314. The Company received approximately $1 billion a year in Intel e-CAP rebates.
The approximately $1 billion a year in rebates that Dell received was spread out unevenly over
the four quarters. There was no quarter where Dell did not receive the payments during the Class
Period.
315. The e-CAP rebates were used to lower Dell’s cost of goods sold. For example, if
Dell’s cost of goods sold was $437.5 billion and the microprocessor chips cost 25% of that
amount (approximate $9.4 billion) and Dell received 10% back in rebates, then Dell lowered its
cost of goods sold by approximately $1 billion. MDFs that it received from Intel were separate
from the Intel rebates. MDFs related to Dell’s advertising, such as Dell including the slogan
“Intel Inside.” Intel paid 50% of the costs of this advertising. Dell received approximately $50-
$100 million a year in MDFs. Unlike the Intel rebates, Dell accounted for MDFs as an SG&A
expense.
316. Dell did not receive e-CAPs from any supplier except Intel, including Microsoft.
Dell and Intel had an exclusive relationship from the inception of Dell until approximately 9/06,
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when Dell began shipping a Dell desktop computer with AMD’s Athlon 64 and Sempron
processors. Despite the exclusive relationship with Intel, beginning in 1999, each year Dell
designed products (desktop computers, laptop computers or servers) with AMD processors, but
these products were never shipped. Each and every time the AMD-based products were to be
shipped to customers, Dell management and senior executives placed a hold on the shipment of
these products due to negotiations between Dell and Intel and the exclusive supplier relationship
between the two companies. These AMD-based products were placed on hold at varying stages
of development, such as design or manufacturing. Dell engineers questioned Dell senior
management regarding why the superior quality AMD processors were not being used in Dell’s
products. The Company’s management was questioned by engineers during the Server Group
Town Hall meetings (held on a quarterly basis).
317. There were meetings to discuss how much Dell would receive in e-CAP dollars,
how these rebates would be spread out and how Dell would account for them. These meetings
typically took place behind “closed doors” at the top executive level. Only about 15 people were
involved in handling the Intel rebates, including M. Dell and Rollins. Intel’s co-founder, former
Chairman and CEO, Andy Grove, was also involved. One reason these meetings were so
exclusive was because there were questions about how the rebates affected fair trade.
318. Dell divided up the money or credits it received from Intel among different
divisions. Dell management discussed the Intel credits at forecasting meetings. They were told
that they came in at M. Dell’s and Rollins’ level and were dispersed throughout the Company.
That is, the credits were included on the various division P&L statements. The Finance Leads
for each division were responsible for putting the credits into the P&L statement for the sector.
The Intel credits likely came into Dell through CFO Schneider’s office. Schneider had his staff
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distribute them among the Finance Leads and Senior Vice Presidents of each major operating
division.
319. Certain sectors of Dell’s operations began to look to them to help it make the
quarter. At one forecasting meeting, the Public Sector was worried about missing the quarter
and someone specifically asked about Intel credits because they were trying to think of anything
that could help the quarter. They were told by the Finance Director that Dell would not be
receiving them. This meeting took place around the time AMD was suing Intel in the U.S.
There were a number of different statements inside the Company as to why Dell would not
receive the Intel credits that quarter. One was that it had to do with microprocessor competitor
AMD suing Intel in the U.S.
320. Dell had a complex and complicated system of compiling statistical profiles of
customer behavior and attitudes and Dell’s sales and expenses on a daily or weekly basis.
Rollins or Schneider admitted:
• “[O]ne of the beauties of the model is that we can see very early on in a quarter what’s happening to volumes, what’s happening to overall cost position and margins . . . .”
• “I want to briefly discuss three topics related to Dell’s business model . . . . First, the timely information flow provided by the Dell business model . . . the direct model provides Dell with information flow advantages that are . . . important. These advantages . . . yield visibility and agility that enables us to precisely adjust to the prevailing market environment faster than anyone else. . . . And on the consumer side, Dell’s knowledge of prospect demands and preference is unparalleled. We track the ROI of price movements and promotions on a realtime basis, and are able to react to substantial shifts in response to profitability in a matter of hours, even minutes. . . . Dell’s direct relationship with customers on the front end . . . enable[s] us to excel in any environment . . . .”
• “The direct-to-customer model also provides Dell with a constant flow of information about trends in customers’ plans and requirements.”
• “Our direct model gives us an unparalleled view in the customer demand which enables us to set robust targets designed to yield balanced, profitable growth. . . . We also manage the direct relationship with our customers across all segments
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and region. This provides us with a highly valuable flow of information that is a key competitive advantage for Dell.”
• “We regularly measure our performance from the customer’s perspective. As examples, we track how easy it is to contact Dell, the accuracy with which orders are fulfilled, if deliveries are on time, overall product quality, whether we correct an issue the first time, and if our customers are treated with courtesy and respect.”
• “Dell’s direct model provides direct and continuous feedback from its customers, thereby allowing the company to develop and refine its products and marketing programs for specific customer segments. This constant flow of communication, which is unique to the direct model, also allows Dell to rapidly gauge customer satisfaction and target new or existing products.”
321. On 9/10/04, Bernstein Research issued a report “initiating coverage” on Dell
which was based on information provided by Dell describing how Dell’s internal information
systems operated:
Dell’s direct model enables it to tightly manage its business to respond quickly to market conditions and deliver highly consistent results. An appropriate analogy is to imagine Dell’s management team running the business in a control room of gauges and dials. The gauges provide daily information on things such as sales volumes, production capacity utilization, component prices and ASPs by product and market. The dials control things such as price, sales incentives, production capacity and inventory. Based on the information on the gauges provided by Dell’s “intimate” business model, the company’s management team is able to constantly tune the business, adjusting the marketing mix based on sales and component costs by increasing/decreasing prices on product A in market B, adding a free memory upgrade in another market based on recently acquired low cost components or a competitive offer, and adjusting sales force incentives in a third market to drive additional volume.
* * *
Dell’s feedback loops also enable it to collect data that allows it to measure and manage everything about a sale, including its pricing/promotion effectiveness and its long term profitability. For each PC assembled and sold, Dell can track a [sic] enormous range of data, including: who sold it, for what price, the serial numbers of the components used, how long it took to assemble and deliver, how many support calls were received and on which issues, etc. Dell’s management can use these data to measure the long term profitability of product lines and customers and flag issues such as a product or component that frequently causes costly support center calls. This enables Dell to more accurately judge the profitability of products, segments and markets and set prices accordingly, and is a key enabler of its systematic (but profitable) share gains.
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322. Because of the way they closely and constantly monitored the Dell sales and
service and support customer interactions, the Dell Defendants knew of the serious and growing
problems with Dell’s product quality and service and support.
323. Weekly Consumer Group sales meetings also discussed the sales in the Consumer
Group and looked at sales trends based on information in the Company’s sales database. CFO
Schneider and CEO Rollins were provided with the weekly sales reports for the Consumer
Group, as well as those for the other product groups at Dell. Certain Consumer Group
employees retrieved sales information from the Company’s sales database, mentioned above, and
provided this information in a report to Rollins and Schneider “at the very least weekly.” The
individual who provided the reports to Rollins and Schneider mentioned this on a regular basis at
the weekly Consumer Group meetings. Rollins and Schneider also received Consumer Group
sales reports on a daily basis in “crunch times,” such as at the end of every quarter. Rollins and
Schneider were “intensely numbers-oriented” (for sales, customer service, etc.).
324. At the Consumer Group weekly meetings, the group discussed sales call center
monitoring (to determine the wait times for handling customer calls, etc.). Dell customers
complained about the inadequate customer service they received. Customers were mainly
dissatisfied with the length of time they were required to wait on the phone prior to speaking
with a customer service call center technician and the fact that their issue was not resolved
during the first call, if at all, due to the lack of knowledge about the computer issue at hand by
Dell technicians. Customers also complained about the fact that they were transferred around
too much from Dell employee to Dell employee in an attempt to fix their computer issue.
Customers complained about not being informed when their order was to be significantly
delayed in shipment.
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325. Dell executives received customer service information in a general report format
from Dell’s internal Customer Service Department on a monthly basis. This information related
to the Consumer Group, as well as other product complaints (i.e., products sold to small
businesses and large businesses). The report came in an e-mail from an automated customer
service e-mail account (i.e., one where no e-mail replies are permitted/handled). The Customer
Service Department tracked customer complaints. That information was tracked based on Dell’s
call center metrics, which included information about wait times, length of call, resolution of
technical issue and customer complaints about customer/product services.
326. Rollins and Schneider received Customer Service Call Center reports on at least a
quarterly basis and probably more often, in e-mail form directly from the Customer Service Call
Center. Sales employees were contacted by Rollins and Schneider directly about customer
service trends via e-mail. It was common knowledge that Rollins and Schneider were “on top
of” customer service complaints/issues because they pressured employees to stay focused on
these issues via various e-mail communications sent out to employees who were in contact with
customers, such as the Sales Department personnel.
327. Dell senior executives, including Rollins and Schneider, received the University
of Michigan (“UofM”) study/survey that came out in 8/05 which showed that Dell customer
satisfaction ratings were at their lowest since 1998. This study was distributed to a large number
of Company employees shortly after (a day or so) it came out. Top level employees received e-
mail communications from Rollins and Schneider in 8/05 about the UofM study. In these
communications, Rollins and Schneider stated that Dell needed to improve its customer
satisfaction ratings. They received these e-mails a day or so after receiving the UofM study.
The UofM study was discussed at length in the weekly Consumer Sales Group meetings and at
other times. Rollins and Schneider were “monumentally” concerned about the UofM study and
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stayed on top of the issues and communicated to Company employees about the importance of
“the Dell customer experience,” as they referred to it. They communicated their concerns
continually via e-mail communications and through Customer Service/Sales Group directives,
which were also discussed at the weekly Consumer Group meetings.
328. After the UofM study, the Company, at Rollins’ and Schneider’s direction,
implemented new and additional training for Dell customer service representatives in order to
attempt to increase the Company’s customer satisfaction levels. Part of this new training
included upgrading the technical tools customer service representatives used to help customers
with computer issues, such as new software, which allowed Dell representatives to view the
customer’s computer screen remotely while the customer was on the telephone with the
representative. Representatives were also trained to focus on fixing the customer’s problems the
first time they called in, rather than the second or third time they called. They were given
additional technical training to accomplish this task.
THE DELL DEFENDANTS’ ILLEGAL INSIDER TRADING
329. During the Class Period, the defendants had both the motive and opportunity to
commit fraud. Several of Dell’s top insiders named as defendants herein and identified below
(the “Insider Selling Defendants”) took advantage of their knowledge of the material non-public
negative information concerning Dell’s business, financials and future prospects by selling
98,859,318 shares of their Dell stock for $3,322,454,411 in illegal insider trading proceeds.
These sales are set forth below:3
3 Multiple one-day sales are aggregated and an average sales price per share used. An asterisk indicates a “contemporaneous” insider sale with a purchase by one of the named plantiffs.
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Shares % Insider Date Sold Price Proceeds Sold
William J. Amelio 3/13/2003 69,091 $26.33 $1,819,434 3/15/2004 13,000 $32.92 $427,960 3/31/2004 72,190 $33.70 $2,432,803 12/6/2004 325,000 $41.47 $13,477,750 5/20/2005 285,000 $39.92 $11,377,200* 6/1/2005 260,000 $40.51 $10,532,600 1,024,281 $40,067,747 93.0%
Donald J. Carty 7/7/2004 174,000 $35.11 $6,109,140 8/17/2004 210,000 $34.59 $7,263,900 7/6/2005 60,000 $39.84 $2,390,400 8/22/2005 120,150 $36.33 $4,365,050 564,150 $20,128,490 72.8%
Jeffrey W. Clarke 3/5/2003 91,500 $26.36 $2,411,940* 8/28/2003 144,712 $32.27 $4,669,856 11/24/2003 71,937 $35.22 $2,533,634 11/25/2003 76,500 $35.11 $2,685,860 12/1/2003 81,500 $35.02 $2,853,880 5/25/2004 11,801 $35.16 $414,923* 11/16/2004 220,000 $40.13 $8,829,000 3/7/2005 195,865 $40.74 $7,979,531 6/20/2005 70,000 $40.41 $2,828,700 963,815 $35,207,325 97.4%
Robert W. Davis 9/9/2003 30,000 $33.29 $998,700 11/24/2003 28,960 $35.27 $1,021,419 9/20/2004 80,465 $35.73 $2,875,014 11/17/2004 32,923 $40.58 $1,336,015 12/20/2004 24,208 $41.98 $1,016,252 196,556 $7,247,401 96.1%
Michael S. Dell 3/13/2003 3,000,000 $26.89 $80,670,000 3/14/2003 7,000,000 $26.53 $185,710,000 3/21/2003 2,000,000 $28.36 $56,720,000 5/22/2003 2,000,000 $30.01 $60,020,000 5/23/2003 5,000,000 $29.56 $147,800,000 5/27/2003 3,000,000 $29.65 $88,950,000* 5/30/2003 1,000,000 $31.31 $31,310,000* 8/19/2003 2,830,000 $33.03 $93,474,900 8/20/2003 3,320,000 $32.53 $107,999,600 8/21/2003 3,850,000 $32.39 $124,701,500 8/22/2003 1,000,000 $33.25 $33,250,000 12/12/2003 4,000,000 $33.81 $135,240,000 12/15/2003 3,000,000 $33.55 $100,640,000 12/16/2003 4,000,000 $32.71 $130,840,000 12/17/2003 500,000 $33.15 $16,575,000 12/18/2003 5,580,000 $33.42 $186,483,600 12/19/2003 2,058,000 $33.57 $69,087,060 6/15/2004 1,800,000 $35.80 $64,440,000
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6/16/2004 3,075,000 $35.44 $108,978,000 6/17/2004 2,325,000 $34.89 $81,119,250 6/18/2004 310,000 $35.00 $10,850,000 6/21/2004 1,290,000 $34.89 $45,008,100 6/22/2004 1,200,000 $34.59 $41,508,000 8/18/2004 3,575,000 $35.19 $125,804,250 8/19/2004 5,095,000 $34.85 $177,560,750 8/20/2004 1,330,000 $34.71 $46,164,300 8/23/2004 1,000,000 $34.90 $34,900,000 11/17/2004 6,725,000 $40.42 $271,824,500 11/18/2004 4,275,000 $40.28 $172,184,650* 85,138,000 $2,829,813,460 26.6%
Martin J. Garvin 3/7/2005 10,000 $40.63 $406,330 6/20/2005 80,500 $40.50 $3,260,350 90,500 $3,666,680 100.0%
Thomas B. Green 6/19/2003 384,000 $32.43 $12,453,120 69.7%
John S. Hamlin 2/28/2003 2,065 $27.00 $55,755 3/17/2003 20,000 $27.75 $555,000 4/2/2003 10,000 $28.26 $282,600* 6/3/2003 20,000 $31.00 $620,000* 6/4/2003 20,000 $31.80 $636,000* 6/18/2003 110,000 $31.88 $3,506,800 9/5/2003 44,676 $34.32 $1,533,157 9/17/2003 30,000 $34.44 $1,033,200* 2/19/2004 20,000 $34.34 $686,780 3/9/2004 2,690 $31.46 $84,627 4/7/2004 10,000 $34.71 $347,100* 5/18/2004 20,000 $34.55 $691,000* 6/2/2004 10,000 $35.54 $355,420 6/18/2004 10,000 $34.76 $347,600 6/21/2004 50,000 $35.13 $1,756,571 6/23/2004 50,000 $35.25 $1,762,500 9/9/2004 70,000 $35.50 $2,485,000 11/16/2004 46,352 $40.03 $1,855,584 2/15/2005 30,000 $39.90 $1,197,021 3/7/2005 80,000 $40.71 $3,256,510 6/6/2005 30,000 $40.82 $1,224,600 6/20/2005 103,660 $40.49 $4,197,410 7/6/2005 9,000 $39.56 $356,035 9/7/2005 71,000 $35.36 $2,510,560* 869,443 $31,336,831 98.9%
Joseph A. Marengi 6/6/2003 280,000 $32.17 $9,007,600* 6/17/2003 74,608 $32.36 $2,414,315 6/18/2003 200,000 $32.01 $6,402,000 7/1/2003 12,100 $31.69 $383,449* 8/19/2003 33,660 $33.65 $1,132,659 9/4/2003 17,304 $34.35 $594,392 9/5/2003 40,000 $34.20 $1,368,000
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9/8/2003 40,000 $34.07 $1,362,800 6/15/2004 90,548 $36.00 $3,259,910 7/2/2004 12,075 $35.45 $428,059* 9/10/2004 236,756 $36.01 $8,525,584 11/16/2004 163,248 $40.06 $6,538,980 12/1/2004 33,365 $41.01 $1,368,299 4/5/2005 70,000 $39.00 $2,730,000* 5/19/2005 40,000 $39.53 $1,581,200* 6/20/2005 200,000 $40.50 $8,100,000 1,543,664 $55,197,246 100.0%
John K. Medica 6/16/2003 157,232 $32.01 $5,032,996 6/18/2003 70,000 $32.02 $2,241,400 9/22/2003 40,000 $34.29 $1,371,600* 12/6/2004 157,724 $41.82 $6,596,018 12/7/2004 385,000 $41.75 $16,073,750 809,956 $31,315,764 98.8%
Michael A. Miles 7/1/2003 300,000 $31.30 $9,390,000* 8/18/2004 360,000 $35.20 $12,672,000 5/17/2005 384,000 $39.20 $15,052,800* 8/17/2005 384,000 $36.88 $14,161,920 1,428,000 $51,276,720 72.8%
Randall D. Mott 5/24/2005 170,000 $39.95 $6,791,500* 5/25/2005 40,000 $39.94 $1,597,600* 6/10/2005 90,000 $39.84 $3,585,600 6/23/2005 70,000 $39.93 $2,795,100 370,000 $14,769,800 73.7%
Glenn E. Neland 3/7/2005 10,000 $40.67 $406,680 3/14/2005 99,000 $39.25 $3,885,750 6/20/2005 10,000 $40.44 $404,400 6/28/2005 50,000 $39.57 $1,978,500 169,000 $6,675,330 98.1%
Rosendo G. Parra 5/20/2003 280,000 $30.35 $8,498,000 5/30/2003 40,000 $31.37 $1,254,800* 7/1/2003 200,000 $31.23 $6,246,000* 12/30/2003 81,216 $34.32 $2,787,659 4/7/2004 120,000 $34.73 $4,167,600* 6/28/2004 145,354 $35.45 $5,152,799* 10/5/2004 200,000 $36.10 $7,220,000* 12/3/2004 34,051 $41.74 $1,421,340 3/7/2005 158,332 $40.70 $6,444,756 6/22/2005 200,000 $40.37 $8,074,000 1,458,953 $51,266,953 88.2%
Kevin B. Rollins 2/28/2003 270,000 $27.01 $7,292,872 5/28/2003 250,000 $30.62 $7,655,000* 8/22/2003 400,000 $33.25 $13,300,000 9/18/2003 250,000 $34.90 $8,725,000*
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6/8/2004 250,000 $35.30 $8,825,052 8/17/2004 345,000 $34.61 $11,940,450 11/16/2004 150,000 $40.26 $6,038,470 12/9/2004 248,000 $42.00 $10,416,002 2,163,000 $74,192,846 99.3%
James M. Schneider 3/17/2003 100,000 $27.73 $2,773,064 3/18/2003 100,000 $28.04 $2,804,427 5/28/2003 250,000 $30.86 $7,715,000* 6/4/2003 50,000 $31.75 $1,587,500* 6/6/2003 50,000 $32.16 $1,608,000* 6/16/2003 50,000 $32.00 $1,600,000 8/19/2003 296,000 $33.38 $9,880,480 9/3/2003 100,000 $34.35 $3,435,000 1/5/2004 140,000 $35.00 $4,900,009 5/26/2004 70,791 $35.40 $2,506,004 5/27/2004 12,900 $35.51 $458,079 6/2/2004 16,309 $35.50 $578,970 10/1/2004 50,000 $36.05 $1,802,500* 11/23/2004 140,000 $40.40 $5,656,000* 11/26/2004 75,000 $40.91 $3,068,250* 12/7/2004 17,802 $41.86 $745,169 12/8/2004 7,198 $41.85 $301,247 3/1/2005 20,000 $40.45 $809,000 5/23/2005 100,000 $40.00 $4,000,000* 5/25/2005 40,000 $40.25 $1,610,000* 1,686,000 $57,838,699 98.6% Totals: 98,859,318 $3,322,454,411
NO SAFE HARBOR
330. The statutory safe harbor provided for forward-looking statements under certain
circumstances does not apply to any of the allegedly false statements pleaded in this complaint.
Many of the specific statements pleaded in this complaint were not identified as “forward-
looking statements” when made. To the extent they were identified as forward-looking
statements when made, specific meaningful cautionary statements identifying important factors
that could cause actual results to differ materially from those in the purportedly forward-looking
statements were not presented. In Dell’s conference calls, as is required, it was not stated “that
the actual results could differ materially from those projected” in connection with any forward-
looking statements made. The Safe Harbor warnings in Dell’s SEC filings and releases as well
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as those made at the start of Dell conference calls were boilerplate and did not materially change
during the Class Period, even though the economic and business conditions in which Dell
operated and the risks facing its business did. Alternatively, to the extent that the statutory Safe
Harbor does apply to any forward-looking statements pleaded in this Complaint, defendants are
liable for those false forward-looking statements because at the time each of those forward-
looking statements was made, the particular speaker knew that the particular forward-looking
statement was false, and/or the forward-looking statement was authorized and/or approved by an
executive officer of Dell who knew that those statements were false when made.
331. Many of Dell’s conference calls or presentations contained no forward-looking
statement disclaimers, e.g., 2/13/03, 2/25/03, 5/15/03, 8/14/03, 11/13/03, 2/12/04, 5/13/04,
8/12/04, 11/11/04, 2/10/05, 5/12/05, or disclaimers that were very limited, often referring only to
the next quarter’s results.
DURA LOSS CAUSATION
332. In 3/05, a series of company-specific negative revelations began regarding Dell
which were inconsistent with, undercut and contradicted the Dell Defendants’ prior Class Period
positive representations. First came revelations from the Japanese antitrust officials of Intel’s
apparently illegal practice of paying large secret end-of-quarter rebate/kickback payments to
computer OEMs like Dell in return for exclusive or near-exclusive relationships – payments
which boosted the OEMs’ reported operating profits and margins. Then, a customer revolt – fed
by the emerging Internet blog system – began in 6/05-7/05. It gave widespread circulation to
consumer nightmares in dealing with computer purchases and computer support and service
issues with Dell and received increasing publicity in the mainstream financial media, indicating
that Dell’s vaunted direct sales method and product quality had decreased markedly and its
customer service and support operations had collapsed. Reports of failures to honor advertised
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sales terms or to provide products with promised features and refusal to honor warranties became
widespread. Defective PC motherboards (capacitors) and lithium batteries created widespread
performance problems – even failures and fires – with Dell computers. Dell’s call centers – now
manned by thousands of fewer personnel, more and more located in India, the Philippines or
other non-U.S. locations, most of whom were ill-trained, part-time workers – disconnected
customers, made them wait on hold for long times (even up to and over an hour), repeatedly
transferred their calls without solving the customers’ problems, refused to even address
Microsoft software issues and refused to honor customer service expectations, rigidly enforcing
Dell’s new, restrictive consumer warranty policies which had shortened the time and breadth of
coverage, implementing Dell’s new “fix-on-fail-only” policy. This resulted in an upsurge in
customer outrage and dissatisfaction which hurt Dell’s sales, not only with potential repeat
customers, but, as adverse publicity spread, with new ones as well.
333. In 6/05, a series of negative Dell-specific revelations began which undercut or
contradicted Dell’s earlier positive statements, indicating their falsity as summarized below. As
these partial revelations caused the truth to enter the market, over time in a series of revelations
often accompanied by continuing false and misleading statements or false reassurances, the
artificial inflation came out of Dell’s stock, damaging prior Class Period purchasers of Dell’s
publicly traded securities.
334. In addition, in mid-8/05, Dell began to report financial results falling short of its
previously forecasted levels of performance, initially with revenue growth and operating
profits/income shortfalls – and ultimately – operating income, operating margin and EPS
declines! However, rather than comply with their obligations under the federal securities laws
and make truthful and complete disclosure, Dell’s insiders opted instead for partial disclosures
accompanied by false reassurances that sought to and did conceal the true nature and extent of
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the problems Dell was encountering – the increasing defects with its products and its inability to
fix its customer support and service operations, which it represented were being remedied with
improving customer satisfaction. Also, Dell continued the falsification of its financial results
which had been going on throughout the Class Period, continuing to report inflated operating
profit margins, operating income, net income and EPS, while understating is warranty
expense. As a result, while Dell’s stock began to decline in 7/05, the stock continued to trade at
artificially inflated levels until a series of company-specific negative revelations in 7/06-8/06. At
that time Dell reported massive financial shortfalls due to continuing customer outrage and
dissatisfaction, exacerbated by the massive spending cuts Dell had engaged in in the past few
years to artificially boost its current period profitability, which was negatively impacting the
revenue and profit growth, and the loss of hundreds of millions of dollars a year in secret (and
possibly illegal) rebates/kickbacks Dell had been receiving from Intel to boost its reported
operating profits and margins. Dell also revealed an SEC investigation into its financial
reporting practices (which Dell had known about but concealed for a year), and that Dell itself
had “discovered” internal financial irregularities and misreporting – all resulting in Dell’s
inability to file current financial statements with the SEC/Nasdaq. Dell also admitted that, as a
result of these business and financial reversals, it would be required to boost corporate spending
by hundreds of millions of dollars and hire almost 10,000 additional employees in an effort to
restore its business so that it could more successfully compete with competitors that were selling
higher quality, more attractive products, often through retailers who supplied otherwise superior
customer service and support. Finally, on 9/11/06, defendants disclosed Dell would not be able
to file its interim financial report for the 2ndQ F07 and that it had received a criminal subpoena
from the U.S. Attorney in the Southern District of New York requesting information on Dell’s
financial reporting practices back to 2002. As a result of the collapse of Dell’s business model
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and operations, Dell’s net income in F07 will be almost $1 billion less than in F06, its future
growth prospects are much worse than were represented during the Class Period and its stock has
fallen sharply from its Class Period highs, damaging prior Class Period purchasers.
CLASS ACTION ALLEGATIONS
335. This is a class action on behalf of purchasers of Dell’s publicly traded securities
between 2/13/03 and 9/8/06, excluding defendants (the “Class”). Excluded from the Class are
officers and directors of the Company, as well as their families and the families of the
defendants. Class members are so numerous that joinder of them is impracticable.
336. These securities include Dell’s common stock and the publicly traded options to
purchase Dell’s common stock which were traded on the U.S. Nasdaq market. Due to the
volume of securities traded, the large amount of analyst attention to Dell, institutional trading in
Dell’s securities and financial coverage of Dell, these securities all traded in efficient markets
throughout the Class Period.
337. Common questions of law and fact predominate and include whether defendants:
(i) violated the 1934 Act; (ii) omitted and/or misrepresented material facts; (iii) knew or
recklessly disregarded that their statements were false; and (iv) artificially inflated the prices of
Dell securities and the extent of and appropriate measure of damages, as well as loss causation.
338. Plaintiffs’ claims are typical of those of the Class. Prosecution of individual
actions would create a risk of inconsistent adjudications. Plaintiffs will adequately protect the
interests of the Class. A class action is superior to other available methods for the fair and
efficient adjudication of this controversy.
339. Proposed Class Co-Lead Counsel, William S. Lerach of Lerach Coughlin Stoia
Geller Rudman & Robbins LLP and Joseph Kendall of Provost Umphrey Law Firm, LLP are
highly experienced in the prosecution of securities class actions as detailed in Exs. A and B
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hereto. Their firms conducted an extensive investigation, including interviewing numerous
witnesses and knowledgeable persons, and drafted this Complaint and have tried securities cases
in this Court.
FIRST CLAIM FOR RELIEF
Violation of §10(b) of the 1934 Act and Rule 10b-5 Against All Defendants
340. Plaintiffs repeat and reallege each and every allegation contained in ¶¶1-339.
341. During the Class Period, defendants carried out a plan, scheme and course of
conduct which was intended to and, throughout the Class Period, did deceive the investing
public, including plaintiffs and other Class members, as alleged in this Complaint and caused
plaintiffs and other members of the Class to purchase Dell publicly traded securities at artificially
inflated prices. In furtherance of this unlawful scheme and course of conduct, defendants, and
each of them, took the actions set forth in this Complaint.
342. Defendants (a) employed devices, schemes, and artifices to defraud; (b) made
untrue statements of material fact and/or omitted to state material facts necessary to make the
statements made not misleading; and (c) engaged in acts, practices, and a course of business
which operated as a fraud and deceit upon the purchasers of the Company’s publicly traded
securities in an effort to maintain artificially high market prices for Dell publicly traded
securities in violation of §10(b) of the 1934 Act and Rule 10b-5. All defendants are sued as
primary participants in the wrongful and illegal conduct and fraudulent scheme and course of
business charged in this Complaint.
343. These defendants employed devices, schemes and artifices to defraud. While in
possession of material adverse non-public information, they engaged in acts, practices, and a
scheme as alleged herein in an effort to assure investors of Dell’s business and financial success
and prospects for continued substantial growth. This included the making of, or the participation
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in the making of, untrue statements of material fact and concealing facts necessary in order to
make the statements made, in the light of the circumstances under which they were made, not
misleading. This conduct artificially inflated the prices of Dell publicly traded securities and
operated as a fraud and deceit upon the purchasers of Dell publicly traded securities during the
Class Period, proximately causing them economic loss and damage as, through a series of
disclosures beginning in 3/05, the prior misrepresentations and other fraudulent conduct of
defendants became apparent, i.e., the truth entered the market and the artificial inflation in Dell’s
stock price came out as the stock price collapsed to as low as $20.65 per share – a company-
specific stock price decline not due to general stock market movements, changed economic
conditions, changed investor expectations or company-specific negative events or information
unrelated to the alleged misrepresentations and other fraudulent conduct.
344. The defendants had actual knowledge of the misrepresentations and omissions of
material facts set forth in this Complaint, or acted with reckless disregard of the truth in that they
failed to ascertain and to disclose such facts, even though such facts were available to them.
345. As a result of the dissemination of the materially false and misleading information
and failure to disclose material facts, as set forth above, the market prices of Dell publicly traded
securities were artificially inflated during the Class Period. Relying directly or indirectly on the
false and misleading statements made by defendants or upon the integrity of the market in Dell
publicly traded securities, plaintiffs and the other members of the Class purchased Dell publicly
traded securities during the Class Period at artificially high prices and were damaged thereby.
346. At the time of defendants’ misrepresentations and omissions, plaintiffs and other
members of the Class were ignorant of their falsity. Had plaintiffs and the other members of the
Class and the market known the truth which was not disclosed by defendants, plaintiffs and other
members of the Class would not have purchased their Dell publicly traded securities, or, if they
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had acquired such publicly traded securities during the Class Period, they would not have done
so at the artificially inflated prices which they paid.
347. As a direct and proximate result of defendants’ wrongful conduct, plaintiffs and
the other members of the Class suffered damages in connection with their respective purchases
and sales of the Company’s publicly traded securities during the Class Period.
SECOND CLAIM FOR RELIEF
Violation of §20(a) of the 1934 Act Against Dell and the Dell Defendants
348. Plaintiffs repeat and reallege each and every allegation contained in ¶¶1-347.
349. The Dell Defendants acted as controlling persons of Dell within the meaning of
§20(a) of the 1934 Act as alleged in this Complaint. By virtue of their business expertise, their
high-level positions, and their ownership and contractual rights, participation in and/or
awareness of the Company’s operations, accounting policies and methods, and/or intimate
knowledge of the false financial statements filed by the Company with the SEC and disseminated
to the investing public, the Dell Defendants had the power to influence and control and did
influence and control, directly or indirectly, the decision-making of the Company, including the
content and dissemination of the various statements which plaintiffs contend are false and
misleading. The Dell Defendants were provided with or had unlimited access to copies of the
Company’s reports, press releases, public filings and other statements alleged by plaintiffs to be
misleading prior to and/or shortly after these statements were issued and had the ability to
prevent the issuance of the statements or cause the statements to be corrected.
350. In particular, each of these defendants had direct and supervisory involvement in
the day-to-day operations, and in the accounting policies and practices of the Company and,
therefore, each is presumed to have had the power to control or influence the particular
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transactions giving rise to the securities violations as alleged in this Complaint, and exercised the
same. The Company controlled the Dell Defendants and all of its employees.
351. As set forth above, Dell and the Dell Defendants each violated §10(b) and Rule
10b-5 by their acts and omissions as alleged in this Complaint. By virtue of their positions as
controlling persons, Dell and the Dell Defendants are liable pursuant to §20(a) of the 1934 Act.
As a direct and proximate result of defendants’ wrongful conduct, plaintiffs and other members
of the Class suffered damages in connection with their purchases of the Company’s publicly
traded securities during the Class Period.
THIRD CLAIM FOR RELIEF
Violation of §20A of the 1934 Act Against the Insider Selling Defendants
352. Plaintiffs repeat and reallege each and every allegation contained in ¶¶1-351.
353. The defendants named in this Claim for Relief are the defendants that sold Dell
stock during the Class Period.
354. As shown in the attached certifications, the named plaintiffs purchased Dell stock
contemporaneously with sales of Dell stock by the Insider Selling Defendants.
355. By virtue of their positions as senior insiders of Dell, the defendants named in this
Claim were in possession of material, non-public information about Dell at the time of their
collective sales of more than $3.3 billion worth of their own Dell stock to plaintiffs and members
of the Class at artificially inflated prices.
356. By virtue of their participation in the scheme to defraud investors described
herein, and/or their sales of stock while in possession of material, non-public information about
the adverse information detailed herein, these defendants violated the 1934 Act and applicable
rules and regulations thereunder.
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357. Plaintiffs and all other members of the Class who purchased shares of Dell stock
contemporaneously with the sales of Dell stock by these defendants: (i) have suffered substantial
damages in that they paid artificially inflated prices for Dell stock as a result of the violations of
§§10(b) and 20(a) and Rule 10b-5 herein described; and (ii) would not have purchased Dell stock
at the prices they paid, or at all, if they had been aware that the market prices had been
artificially inflated by defendants’ false and misleading statements.
PRAYER
WHEREFORE, plaintiffs pray for relief and judgment, as follows:
A. Determining that this action is a proper class action, certifying plaintiffs as class
representatives under Rule 23 of the Federal Rules of Civil Procedure and designating this
Complaint as the operable complaint for class purposes;
B. Awarding compensatory damages in favor of plaintiffs and the other Class
members against all defendants, jointly and severally, for all damages sustained as a result of
defendants’ wrongdoing, in an amount to be proven at trial, including interest thereon;
C. Awarding extraordinary, equitable and/or injunctive relief as permitted by law,
equity and the federal statutory provisions sued hereunder, pursuant to Rules 64 and 65 to assure
that the Class has an effective remedy, including freezing or otherwise restricting the disposition
or transfer of the insider trading proceeds of the Individual Defendants;
D. Awarding plaintiffs and the Class their reasonable costs and expenses incurred in
this action, including counsel fees and expert fees; and
E. Awarding such other and further relief as the Court may deem just and proper.