Dell's Shame: Intel Payola Propped Up Company's Earnings, SEC Says

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In the wake of the dot-com crash, Dell was the darling of the media and investment worlds. While other companies were struggling to survive, good old Dell was a paragon of success. Unlike its competitors, Dell used aggressive supply-chain management to deliver value to its investors.

As the company met or exceeded its earnings per-share targets quarter after quarter, all kinds of stories sprang up about what made the company so special. Usually it was their abnormally amazing supply-chain management.

"Still relentlessly striving to get better faster, Dell intends to slash $2 billion in costs. CFO Jim Schneider has indicated that much of the cuts will come from manufacturing operations and the supply chain," Fast Company wrote in 2004. "That will put even more pressure on Dell's component makers. Michael Dell is fond of saying that in the high-tech business, you either grow or die. It all just happens much, much faster when you're living in Dell time."

But now we know, courtesy of an SEC investigation, that the Dell secret sauce was payments from Intel that kept rival AMD's chips out of Dell boxes.

The Economist reports on the whole sordid affair, which ended with the SEC extracting a $100 million fine from the Texas firm, though Dell neither admitted nor denied guilt in the settlement (emphasis added):

The penalty seems rather light given the gravity of the SEC's accusations. According to the commission, Dell would have missed analysts' earnings expectations in every quarter between 2002 and 2006 were it not for accounting shenanigans. This involved a deal with Intel, a big microchip-maker, under which Dell agreed to use Intel's central processing unit chips exclusively in its computers in return for a series of undisclosed payments, locking out Advanced Micro Devices, a big rival. (Intel is expected to settle a long-running anti-trust case that has highlighted these payments in the next couple of weeks.) The SEC's complaint said Dell had maintained "cookie-jar reserves" using Intel's money that it could dip into to cover any shortfalls in its operating results.

The SEC says that the company should have disclosed to investors that it was drawing on these reserves, but did not. And it claims that, at their peak, the exclusivity payments from Intel represented 76% of Dell's quarterly operating income, which is a breathtaking figure. Small wonder, then, that Dell found itself in a pickle when its quarterly earnings fell sharply in 2007 after it ended the arrangement with Intel. The SEC alleges that Dell attributed the drop to an aggressive product-pricing strategy and higher than expected component prices, when the real reason was that the payments from Intel had dried up.

It's amazing to read the investor conference call transcript from the first quarter of 2007, the period in which three-quarters of the company's operating income came from the Intel payments, according to the SEC.

Intel is hardly mentioned, meriting just two short comments. Even an analyst question about Dell's then-new deal with AMD, which signaled the end of the payments, didn't generate a peep about the possible impact of the Intel arrangement. Yet insiders at the company must have known that they were in trouble, if the SEC allegations are correct.

It's yet another example to stack on top of the maxim: when it seems too good to be true, it probably is. Even in "Dell Time."

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Alexis C. Madrigal

Alexis Madrigal is the deputy editor of TheAtlantic.com, where he also oversees the Technology Channel. He's the author of Powering the Dream: The History and Promise of Green Technology. More

The New York Observer has called Madrigal "for all intents and purposes, the perfect modern reporter." He co-founded Longshot magazine, a high-speed media experiment that garnered attention from The New York Times, The Wall Street Journal, and the BBC. While at Wired.com, he built Wired Science into one of the most popular blogs in the world. The site was nominated for best magazine blog by the MPA and best science Web site in the 2009 Webby Awards. He also co-founded Haiti ReWired, a groundbreaking community dedicated to the discussion of technology, infrastructure, and the future of Haiti.

He's spoken at Stanford, CalTech, Berkeley, SXSW, E3, and the National Renewable Energy Laboratory, and his writing was anthologized in Best Technology Writing 2010 (Yale University Press).

Madrigal is a visiting scholar at the University of California at Berkeley's Office for the History of Science and Technology. Born in Mexico City, he grew up in the exurbs north of Portland, Oregon, and now lives in Oakland.

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