please explain’ from both the Australian Stock Exchange and the Australian Securities and Investments Commission for misleading the market on its earnings for the December half of this financial year. In the grand scheme of things, Target’s fudged half-year accounts was a miniscule $21 million out of total net earnings of $1.4 billion for the Wesfarmers conglomerate. But the profit deception appears to have been a desperate play by some executives to stave off a merger of Kmart and Target by creating the impression that a turnaround plan was gaining traction. Losing patience with Target and mindful of the competitive landscape in the mass merchandise retail formats, Wesfarmers decided to fold Target’s non-store operations into its Kmart architecture, a decision that was announced publicly when half-year results were released on February 23. Target has a long and proud history in Australian retailing and in Geelong, Victoria, a heritage that runs back to 1926 when the business was formed as one of the pioneering discount retailers, Lindsay and McKenzie. The chain was acquired by Myer Emporium in 1968 and rebranded as Target in 1973. For an extended period it was the best performed brand for Coles Myer after the 1985 takeover of Myer by GJ Coles & Coy. The Geelong connection is a critical factor in the current Target debacle.  Headquartered outside Melbourne, the chain had more independence than the other Wesfarmers businesses, and that was happily accepted while the financial results were good. Target’s ‘next generation’ Chatswood store However, Target’s sales, earnings and market share have nosedived and Wesfarmers started to evaluate options, including a merger with Kmart which has been gaining momentum on the back of a long transformation program that started in 2008. Wesfarmers quite likely also considered divesting Target just as it considered selling off Kmart when it was struggling. But the merger option won the day, an option that inevitably would lead to the transfer of Target’s head office to Kmart’s Melbourne base. The head office transfer was confirmed last week, a decision that will result in redundancies for up to 25 per cent of Target’s 900 Geelong-based employees. The outcome of a merging of Target and Kmart was obvious, and it now seems towards the end of last year some executives in Target’s head office attempted to thwart any merger possibility by creating evidence that a business transformation program begun in 2013 was delivering results and justified the chain continuing as a standalone operation. The fillip in earnings for the December half proved to be insufficient to prevent the merger proceeding and, in evidence of the angst in the Geelong enclave, on March 24 the media and Wesfarmers management were alerted by someone within Target of the $21 million fiddle in the accounts. Stuart Machin, who along with Ian McLeod shared Inside Retail Magazine’s top retailer of the year ranking in 2012 for his success in rejuvenating Coles’ food and liquor business, was effectively sidelined by the February 23 merger announcement that placed the stewardship of the two discount department store brands under the control of Kmart MD, Guy Russo. The revelation of the profit fiddle, which was linked to questionable deals with overseas suppliers, led Machin to resign on April 8 despite claiming he had no knowledge of the deceptive accounting that Wesfarmers engaged financial services firm, Ernst & Young, to investigate. Machin said he was dismayed to learn of the accounting irregularities but accepted responsibility as they had happened on his watch. “During my tenure at Target, although the financial results were frustratingly disappointing, I feel we made enormous progress in reshaping a very troubled business,” Machin said in statement released to the Australian Stock Exchange. Old habits die hard Machin was always aware of the importance of developing a strong culture in an organisation, a focus that had been germane to the rejuvenation of the Coles business and that had been a key element of his attempts to reshape what he described on his exit as a. “very troubled business”. However, it seems that some old bad cultural habits persist because the questionable supplier deals that underpinned the half year profit over-statement have occurred previously at Target. Last December, with end of half financial accounts taking shape, buyers negotiated deals with 31 overseas suppliers to collect rebates that were not due in first half-year to boost profitability on the basis the retailer would agree to pay higher prices on goods in the current second half. Without the deals, Target’s earnings before interest and tax would have been just $53 million, around one-third below the reported $74 million in Wesfarmers’ half-year accounts. Target attempted to use the advance payment of rebates tactic previously, only to be sprung by a supplier complaint to the ACCC. On that occasion, local suppliers were tapped on the shoulder to help the retailer’s bottom line. Target also tried to pass the hat around to local suppliers in a disastrous two-year period when American retailer, Warren Flick, tried to prop up earnings that were damaged by his decision to import apparel ranges from Asia that were developed for the North American market. While the Wesfarmers Ernst & Young investigation has focused on the deals struck with overseas suppliers that are now being terminated, it seems that local suppliers were also being pressured in the December half to pay promotional and advertising levies in advance to give the half-year earnings more zest. Revelations that some local suppliers were receiving demands for payments above agreed trading terms seem certain to be investigated by the ACCC as a breach of unconscionable conduct provisions of competition laws. If substantiated, the demands would demonstrate a similar behaviour to the Coles supermarkets promotional charges that resulted in an $11.5 million settlement of legal proceedings initiated by the ACCC as well as refunds to more than 200 suppliers. Bringing forward unearned income and demands for payments over and above trading terms are tactics that have been used by other retailers to improve their reported earnings. Dick Smith attempted to raise funds through advance advertising and promotional contributions late last year before it collapsed, while Woolworths has landed in the Federal Court defending an ACCC action over a ‘mind the gap’ promotion – the ‘gap’ being a $50 million shortfall on the supermarket retailers profit projections! In a statement issued by Wesfarmers on April 11, the company’s CEO, Richard Goyder, said Ernst & Young had identified that the overseas supplier deals underpinning the $21 million profit gain did not meet the group’s accounting policies and operating standards. Goyder said the arrangements had no cash flow implications for the half-year to December 31 and were not “material” in their financial impact on the group’s overall financial results and the profit benefit would be reversed out in the full financial year due to higher product costs. Goyder said the arrangements had not been disclosed to Wesfarmers or its auditors and he noted that action would be taken against, “the Target employees who were found to be involved”. Given his attempts to stop the ACCC from gaining further powers in amendments to competition laws, it is little wonder that a frustrated and furious Goyder would describe the Target profit fiddle as, “mind-blowingly stupid”. Where to for Target? If the original idea for the profit fiddle was to fend off a merger with Kmart, the reality is that it has backfired completely and is likely to result in a much broader re-shaping of Target’s administration and significant changes in its buying and finance teams. While he already left Target, the former CFO, Graeme Jenkins, has also paid a price for the profit fiddle, losing the job he started this month with the British retailer, Pets At Home, after Goyder said he should have been aware of the supplier deals that were outside Wesfarmers accounting and corporate governance standards. At least two other unnamed senior executives have left Target in the wake of the Ernst & Young investigation. Guy Russo, who joined Kmart in 2008 after a successful career with the McDonalds fast food chain, was appointed to head the merger of Kmart and Target after the latter’s three-year transformation plan struggled to lift results. The merger, which Wesfarmers had contemplated “on and off for years”, will integrate many back of store functions to reduce costs and improve efficiency, while also potentially restructuring and right sizing store networks. Target’s buying team will be under the microscope as much for problems with the direct sourcing model introduced in 2001 under Warren Flick and developed further under Launa Inman, as for its trading terms agreements. Russo must determine whether or not Machin’s transformation program was recapturing Target’s value fashion positioning with shoppers even if the plan was not translating into a lift in financial results. He faces a challenge in uprooting the Geelong business and integrating its independent attitudes and procedures, a challenge that may not see any immediate financial gains. Notwithstanding the current turmoil, Target’s rejuvenation will require patience. Russo took five years to turnaround Kmart, and Machin had only been executing his plan for a little over two years. Access exclusive analysis, locked news and reports with Inside Retail Weekly. Subscribe today and get our premium print publication delivered to your door every week.