SEC Details Dell's 'Drug' Dependency on Intel's Cash

Dell has paid a $100 million penalty to settle the years-long Securities and Exchange Commission (SEC) investigation into its financial practices, but the sum is spare change compared to the billions of dollars that Dell received from Intel over the course of several years as a ’rebate’ for not selling PCs and servers powered by AMD processors, according to the SEC.

Details of the relationship between the two companies were released Thursday in a 61-page document that alleges Dell repeatedly sought more and more cash from Intel to cover earnings shortfalls. It was a habit that former CEO Kevin Rollins eventually referred to as a ’drug’ that Dell needed to ’get off’ of, according to the SEC.

In the filing, the SEC alleges that ’Intel effectively paid Dell not to use processors manufactured by Advanced Micro Devices’ and that Dell executives including chairman and CEO Michael Dell, former CEO Kevin Rollins, former CFO James Schneider and others allegedly failed to disclose significant benefits it received from Intel and materially misrepresented the basis for its improving profitability.

From fiscal 2003 to fiscal 2007, Intel paid Dell an increasingly higher amount of cash each quarter for Intel exclusivity, according to the SEC. Initially, the payments accounted for about 10 percent of Dell’s operating income in fiscal 2003. That figure increased to 38 percent in the 2006 fiscal year and peaked at 76 percent in the first quarter of fiscal 2007, according to the SEC.

’Dell’s most senior former accounting personnel engaged in a wide-ranging accounting fraud by maintaining a series of ’cookie jar’ reserves that it used to cover shortfalls in operating results from FY02 to FY05,’ according to the complaint.

Intel began providing additional ’rebates’ to Dell and other PC makers at least as early as 2001, money that was different and separate from normal pricing discounts, according to the SEC. The payments were not disclosed and eventually were included in multiple antitrust investigations against Intel.

For Dell, the payments from Intel soared from $61 million in the first quarter of fiscal 2003 to more than $720 million in the first quarter of 2007, as Intel paid off the PC maker for avoiding AMD processors, chips that at the time many believed to be better than Intel’s technology, according to the SEC.

’The increase in Intel payments to Dell coincided almost exactly with AMD’s introduction of its Opteron CPU that was, in the view of many, technologically superior to Intel’s competing CPU,’ according to the complaint.

NEXT: The Mother Of All Programs

In late 2001, the SEC alleges, Intel began a program known as ’MOAP,’ short for ’Mother of All Programs,’ which gave Dell a six percent rebate for all CPU purchases. The percentage evolved over time and ultimately became a percentage of Dell’s entire net spend with Intel, up to 14 percent by fiscal year 2007, according to the complaint.

From the first quarter of fiscal 2003 to the first quarter of fiscal 2007, Intel’s ’rebate’ payments to Dell totaled $4.3 billion, including $3.4 billion in percentage-based rebates and $881 million in lump sum payments that was used to help meet Wall Street earnings estimates, according to the SEC.

’As a percentage of Dell’s total costs of goods sold, net Intel spend increased from 17 percent to 22 percent over the period,’ according to the complaint.

Dell considered using AMD processors as early as 2001 and in February 2002 one Dell employee reported that a meeting attended by Michael Dell and Rollins discussed how adding AMD would impact Intel’s MOAP payments.

According to the SEC complaint, ’Dell subsequently sought higher payments from Intel for not using AMD CPUs. In June 2002, in response to an action item from a meeting with Michael Dell and Rollins, Dell's procurement team developed a ’laundry list of things’ that the company would require Intel to do for Dell to ’remain monogamous.’ A subsequent version of the list was provided to Michael Dell and Rollins and included an item seeking an increase in MOAP funding. In July 2002, Rollins reported to Michael Dell that Intel ’seem[s] to want to do whatever it takes to persuade us to not go with [AMD].’’

In 2004, Intel’s payments to Dell again increased significantly when, according to the SEC, Dell considered striking a deal with Microsoft, AMD and IBM (a deal known as ’MAID’) that would have resulted in Dell taking an ownership interest in AMD and shifting 25 percent of its CPU purchases to AMD.

The SEC complaint further alleges, ’as Dell was negotiating the MAID deal, however, Intel's CEO told Michael Dell that Intel was prepared to increase its … payments to Dell significantly. The SVP and his Intel counterpart then negotiated a ’Tactical and Strategic Fund’ through which Intel agreed to pay Dell $258 million over four quarters from Q4FY04 to Q3FY05. On September 30, 2003, Intel's CEO and Michael Dell shook hands on a new … deal. Two days later, Michael Dell said to Rollins, Schneider, [an unnamed Dell senior vice president], and others: ’We need to close down the [MAID] discussions and move on.’’

The Dell senior vice president also told Michael Dell and Rollins that if Dell went ahead with the MAID program, Intel would not only reduce or cut its payments to Dell but it might redirect the money to Dell’s PC competitors, according to the SEC.

NEXT: 'A Bad Way To Run The Railroad'

Over the following 10 quarters, Intel continued to increase its payments to Dell to not use AMD processors, according to the complaint.

’Dell would often seek additional rebates from Intel in order to close a gap between its forecasted results and its earnings targets. Dell was quite open with Intel about the reasons it was requesting additional money,’ according to the complaint.

In early 2004, Dell executives talked about needing ’$75 million from Intel’ to meet Wall Street estimates of 28 cents per share. In an e-mail from that period, Schneider referred to the senior vice president involved in the Intel negotiations as ’Mr. ’the quarter is on your shoulders,’’ according to the complaint.

’Ultimately, Intel provided Dell a $70 million lump sum payment that quarter. … Dell met analysts’ EPS consensus of 28 cents,’ according to the complaint.

On April 3, 2004, Rollins sent Michael Dell an e-mail noting that Dell’s reliance on Intel payments was becoming a problem. ’For 3 qtrs now, Intel money has made the qtr. A bad way to run the railroad,’ according to the complaint.

The alleged payoff continued for several more quarters as Intel made payments to Dell that helped Dell make its quarter, according to the SEC. In the 20 quarters from the first quarter of FY02 through the fourth quarter of FY06, Dell met or exceeded earnings expectations every time. ’Dell would have missed the EPS consensus in every quarter had it not received … payments from Intel,’ according to the SEC.

NEXT: 'We Are Going To Have To Get Off Their Drug'

During one quarter, Rollins reportedly wrote in an e-mail to Michael Dell, Schneider and other Dell executives regarding Intel, ’we are going to have to get off their drug and leave them within 18 months if this is their position on Opteron,’ according to the complaint.

In May 2006, Dell finally announced it planned to add AMD processors products before the end of the year. In response, Intel cut its payments to Dell by more than quarter of a billion dollars, according to the complaint. In its next earnings call, Dell attributed the subsequent decline in operating income to being too price aggressive in the market and to higher-than-expected component costs.

’Dell's apparent success was hostage to Intel's willingness to continue paying Dell hundreds of millions of dollars,’ according to the complaint.

In a statement released Thursday, the SEC said Michael Dell and Rollins each agreed to pay a $4 million penalty and Schneider agreed to pay $3 million to settle the SEC charges against them without admitting or denying the SEC’s allegations. In addition, former regional vice president of finance Nicholas Dunning and former assistant controller Leslie Jackson also agreed to settle the SEC’s charges.

’Accuracy and completeness are the touchstones of public company disclosure under the federal securities laws,’ said Robert Khuzami, director of the SEC’s Division of Enforcement, in a statement. ’Michael Dell and other senior Dell executives fell short of that standard repeatedly over many years, and today they are held accountable.’

Added Christopher Conte, associate director of the SEC’s Division of Enforcement, in a statement, ’Dell manipulated its accounting over an extended period to project financial results that the company wished it had achieved, but could not. Dell was only able to meet Wall Street targets consistently during this period by breaking the rules.’