Friday, December 01, 2006

Calls of Note Part 1

Friedman, Billings, Ramsey out with a very interesting piece on Dell (NASDAQ:DELL), saying that their analysis of Dell's warranty accruals points to at least three troubling conclusions.

First, it appears that Dell regularly uses warranty accruals to materially manage margins and earnings, rendering the reported results less useful for gauging actual margin trends.

Second, as of the last quarter for which a 10Q is available, the cost of actual claims as a percentage of product sales was rising steadily - up 30% YOY in FY06, reducing cash gross margin by 60bps - and costs may be heading higher.

Third, Dell's warranty disclosure is unusual, possibly unique, making it difficult to identify Dell's warranty accruals using only Dell's SEC filings. For this reason, firm believes this information is not in the consensus, and that restatements of earnings may be coming if this turns out to be one of the issues currently under SEC investigation.

Firm estimates that under-accrual for warranties has caused EPS overstatement of 2-8 cents in five of the last 12 quarters for which data is available. As of F1Q07, warranty cash costs were running at 46% of the warranty reserve, compared to 27% for HP and 13% for EMC. The evident trend is overstatement of gross margins since CY3Q03.

Notablecalls: Very interesting! If the warranties were the case in the last qtr (Oct) as well, don't think the stock should trade as high as it does. So much about the margin improvement.. Thunk DELL is heading lower near-term as the issue gets traction on the Street.

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