Court hears rebates key to Dick Smith float

Court hearings into Dick Smith's collapse have entered the home stretch. Photo / Luis Enrique Ascui

The improved profitability of Dick Smith before it floated on the stock market in 2013 was "largely" through negotiation of additional payments from suppliers under its controversial rebate program, a court has heard.

Giving evidence in the NSW Supreme Court on Wednesday, former chief financial officer Michael Potts defended the company's policy of maximising so-called "over-and-above" rebates - additional payments attached to stock purchases that would be recorded as an increase in profits or a reduction in marketing expenses.

"I would say that there was a strategy within the business to maximise rebates," said Potts, in response to questions from receivers Ferrier Hodgson.

"That was part of the prospectus when we went to market. We talked about improvement in the profitability of Dick Smith - that was largely through negotiation for additional rebates and support from suppliers.

"If we were able to achieve additional rebates and support from suppliers and improve the profitability of the business, then that was good business."

Asked by barrister Jeremy Giles SC, representing Ferrier Hodgson, why the company wouldn't simply negotiate a lower price for a given product, Potts said that would be leaving "money on the table".

"Generally the way you can go back and get additional money is by saying to the vendor or the supplier, listen, we'll help you drive more business in the form of promotional activity," he said.

"We're asking for support not in the price of your product but in the form of additional marketing, or promotion on that product, to support driving your business and our business.

"If we went back to a vendor and said, by the way, we're now renegotiating trading terms, that would probably be met with resistance. If we went to the supplier and said, we'd like to promote your product and we're asking for assistance, there was a different allocation of funds available to that supplier.

"If you're a street-smart buyer, you're negotiating for more than your fair share of those funds that would otherwise go to JB Hi-Fi or Harvey Norman."

Asked whether there were any systems or controls in place around stock range and quality, Potts said it would "largely be determined by the buyers and that is very subjective".

In its report into the company's failure, not presented to court, liquidator McGrathNicol found that as sales fell, Dick Smith increasingly made purchasing decisions based on rebates the company could earn rather than what customers actually wanted to buy.

That led to a build-up in unsaleable and outdated inventory, which had to be liquidated in the peak 2015 Christmas period, leading to intense margin pressure that ultimately impacted the company's ability to pay its debts.

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

On Tuesday, the court heard from Anchorage Capital Partners managing director Phillip Cave, who represented private equity firm on the Dick Smith board until early last year.

Anchorage bought Dick Smith from Woolworths for A$20 million in 2012 and made A$500 million after floating it on the stock exchange nine months later.

Cave stressed that the rebate program was inherited from Woolworths and continued under Anchorage's management. "The policy started in Woolworths' time," Cave said. "Woolworths' position was to maximise rebates - it was fully, clearly out there. It didn't start with us. We decided to continue."

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

On Wednesday, Potts was also questioned on a number of arrangements entered into with suppliers late in 2014, negotiated by property and supply chain director John Skellern and his procurement team.

In one case, Dick Smith renegotiated its contract with Optus, extending it by two years until June 2020 - for which Dick Smith received a credit note of A$1 million.

In a December 2014 email to a member of Dick Smith's procurement team, one lighting contractor wrote: "We probably need to discuss your purchase potential and if you wish to include price-inflated rebates that would automatically add a percentage to the purchase price for rebate back to you."

Another email between Dick Smith's procurement team and financial services company FlexiGroup referred to "$500,000 payable upfront in December 2014 with a clawback", while an email with a flooring company discussed a $300,000 "upfront contribution for marketing and promotional activity".

Pressed by Giles on whether he was aware of any suppliers - including of services and products as well as sales inventory - inflating the price and rebating the difference back to Dick Smith, Potts said he wasn't.

"Do you know any reason why MR Skellern [was] negotiating these various arrangements in December 2014?" Giles asked.

"That's probably a question for Mr Skellern," Potts said.

Along with Cave, Wavish and Skellern, others already questioned include former company secretary David Cooke, directors Lorna Raine and Robert Ishak, and chairman Rob Murray.

The hearings continue.