In October of 2006, I reported on Systemax (NYSE:SYX), as I was concerned about their late filing and the possible red flags at the company. Within the report I touched on a subject that I believe has now become the elephant in the room.
Everyone knows that rebates are a nuisance for consumers and many retailers wish they’d go away. It's one thing if a manufacturer uses one occasionally to reduce excess inventory or draw attention to a hot product. It is widely known in the retail business that a percentage of consumer rebates never get redeemed; in fact, a percentage of the checks go uncashed.
But a business takes on an entirely different character – with a very different business risk profile -- if it depends on rebates for its market share, or worse, if it intentionally connives to cheat consumers out of their rebates by creating artificial barriers to getting them.
Rebates and Systemax
There are several factors that have to be weighed carefully by investors to assess the impact of the rebate business on Systemax.
1) TigerDirect.com chronically appears on the internet as the low price leader on numerous “hot” consumer electronics products – especially on various comparison shopping sites – with the rebate netted into the comparison price. TigerDirect appears to be depending heavily on rebates in the notorious price-sensitive internet shopping game.
2) All of its rebates (many of which are offered through Tiger itself) are processed at a single processing company: OnRebate.com
Even Wikipedia describes Tiger and their controversial rebate division.
Look at the amount of complaints with the Better Business Bureau.
I took it a step further and called the Florida Attorney General’s office ourselves. When I asked how many complaints they have against Onrebate the answer was, “too many to count”. Although unscientific, that answer is disturbing.
Here’s what makes this interesting: Systemax owns OnRebate.com! So there’s a huge potential for related party interest here – consumers’ failures to redeem rebates flow to the benefit of the company offering those “low prices” and making the sales predicated on those rebates.
But nowhere in any of the SYX filings do we read about OnRebate – its almost as if the company doesn’t exist! There’s no disclosure of Tiger’s dependence on rebates in its sales figures, and no disclosure of the impact of rebates on its accounting.
Rebates are a “black hole” in Systemax’s accounting and filings. We have no idea how rebate accounting is handled by company and no idea how it impacts Systemax on a larger scale. For that matter, the word “rebate” does not even appear in Systemax’s filings, even though it appears to be a cornerstone of Tiger Direct’s business model. Even when you look at the Systemax Corporate Website under subsidiaries and divisions, OnRebate is noticeably absent.
We do not even know how the company was formed and how it got into the Systemax family. The transaction is undocumented.
Why is this so relevant to the financials? Unredeemed rebates are “pure profit” to the manufacturer. I wonder if “controlling” the rebate process – which sometimes seems to include refusing to return the consumer’s original proof-of-purchase on declined rebates -- is what is making the difference between a company that generates cash and one that burns cash. Suppose 20% of all Systemax items carry rebates and the average rebate (a sampling for the 11 best selling items on Tiger Direct’s website) is worth 30% of original purchase price for non-Systemax branded products. For a business model that ekes out a 2% TTM net income margin, the handling of rebates (or mishandling) could make the difference between a profitable and unprofitable company. I have modeled this out a few different ways and have come to the conclusion that non-payment or delayed payment of 17% of the rebates could account for 100% of the cash flow from operation over the TTM.
I have also noted that Systemax does not disclose its mail-in rebate redemption rate estimates, which could give us a clearer picture of the financials. Notably, such disclosures are made by Systemax competitor PCMALL in their filings.
Further, if the rebate business is actually an important factor in Systemax’s financial results, it should be booked explicitly in the accounting – including redemption percentages, and reserves set aside for uncollected rebate liabilities.
Management and Controls
Shareholders must rely on the assumption that management is being forthright with investors on the financial health and business practices of the company. We note this management has had a prior run-in with the FTC regarding its business practices.
In December of 2005, Deloitte & Touche resigned as their auditors and issued the company a letter of material weakness of internal controls. The new audit team of Ernst and Young has issued the company the same notice of material weakness. Management of Systemax acknowledges the greater problem and has disclosed:
“ We have a significant amount of work to do to remediate the items we have identified. In the course of completing our evaluation and testing we may identify further deficiencies and weaknesses that will need to be addressed and will require remediation. We may not be able to correct all such internal control deficiencies in a timely manner and may find that a material weakness or weaknesses continues to exist. As a result, management may not be able to issue an unqualified opinion on the effectiveness of the Company's internal control over financial reporting as of December 31, 2007.” (emphasis ours)
Systemax suffered another setback on September 29 0f 2006 with the resignation of their VP, Controller, and principal accounting officer Michael Speiller. He was replaced with Thomas Axmacher who assumed all roles except that of principal accounting officer. The company is still looking for internal auditors and internal accountants.
Mr. Axmacher was formerly with Curative Health Services. He resigned from them effective April 30, 2006...they had gone Chapter 11 just a month earlier on March 27.
I am not stating that Systemax is committing fraud. What I am suggesting is that something seems wrong – something that becomes even more suspicious through its omission. While Systemax spends the next year becoming more “disclosure friendly”, I suggest they start with the making transparent its rebate system, policies and accounting. The company has a long road ahead of them --who knows what interesting twists and turns this can bring for investors.
One thing for sure – disappointed stockholders will not be able to demand rebates on their share purchases at these lofty levels.
Cautious Investing To All.
Disclosure: Author is short SYX.
SYX 1-yr chart: