Seagate Dumps Distributor After Audit Inquiry

The Scotts Valley, Calif.-based hard drive maker claims that eSys refused to provide sales records to third-party auditors hired by Seagate and the distributor revealed that an audit likely would reveal irregularities.

"We took steps today to begin the process of terminating our distributor relationships with eSys Technologies and have ceased shipments of our products to eSys," Seagate said in a Nov. 7 8-K filing with the SEC.

Executives from Seagate and eSys couldn't be reached for comment.

eSys accounted for about 5 percent of Seagate's revenue in the fiscal year ended June 30 and 6 percent in the first fiscal quarter ended Sept. 29, according to Seagate.

"While we are making every effort to replace the revenue we have generated through sales to eSys with new and existing distributor customers, we can give no assurance that our revenues and operating results, particularly in the short term, will not be adversely affected by our termination of our distributor," Seagate said in the filing.

Seagate initiated steps toward an audit of eSys' POS records in early October to confirm the accuracy of the distributor's credit claims under the storage vendor's sales incentive programs. Discussions regarding the scope of work, timing and selection of third-party auditors continued until last week, when eSys informed Seagate that it would deny auditors access to the records, according to Seagate. Seagate claims it has a contractual right to seek an audit in the agreement between the companies.

"eSys officials also indicated to us that an audit would likely reveal irregularities in eSys' compliance with the terms of our incentive programs and other unspecified irregularities," Seagate said in the filing. "In addition, eSys has failed to make full current payments on its obligations to us. Accordingly, today, we notified eSys that we are terminating our commercial distributor relationships with eSys."

Through Nov. 5, eSys' outstanding balance to Seagate was about $50 million, down from $103 million at the end of its fiscal first quarter. Seagate said it will record $40 million of allowance for doubtful accounts due to its uncertainty of collecting the rest of the money.

"We intend to make every effort to collect all amounts owed by eSys as promptly as possible. Any amounts recovered on these receivables will be recorded in the period received," Seagate said in the 8-K filing. "While we are terminating our ongoing distributor relationships with eSys, we will continue to aggressively pursue our contractual audit rights as well as any claims that may be assertable against eSys as a result of material breaches of the distribution agreements and any intentionally wrongful conduct that may have occurred."

ESys was founded in Singapore in 2000 and has grown to a $2 billion company with offices in 38 countries. Its U.S. operations are based in Chino, Calif.

ESys said in a statement that it "strongly refutes any allegations of irregularities in its compliance of the agreements." The distributor also said it declined Seagate's requests for an "intrusive" audit because of its commitment to the confidentiality of data relating to its customers and other vendors.

"Unfortunately, the intrusive nature of the audit would not be justifiable to our worldwide business partners under normal business practices," according to eSys.

In addition, eSys said Seagate "repeatedly refused to provide shipments as required under the agreements" during negotiations between the companies.

"Despite this, and as a sign of good faith, eSys has continued to pay Seagate for invoices raised, bringing down outstanding [balance] from $103 million to $50 million, a fact acknowledged by Seagate as well," eSys said in the statement. "ESys has a long history of meeting its commercial liabilities in full and intends to continue this record."