Getting to the Bottom of Computer Associates' Books

There might be a company in the world with more baffling accounting than Computer Associates International Inc.--but, then again, maybe not. The Long Island software company has made two major shifts in the way it presents its financials over the past three years. And ongoing probes of CA's finances by the Securities & Exchange Commission and the Justice Dept. only add to the bewilderment. The feds have subpoenaed CA's auditors and are zeroing in on how it recognized revenues, say former CA executives interviewed by investigators.

All this makes it hard for investors to tell how CA is performing. "We're not saying they're cooking the books, but there's ample evidence to wonder if everything is on the up-and-up," says Edward Jones analyst Arthur Russell, who recently suspended coverage of CA because of the accounting issues.

CA says it has not violated accounting rules. And Walter P. Schuetze, former chief accountant for the SEC who joined CA's board this summer, says he has reviewed the company's past and current accounting practices and has confidence in them. He says that today, "CA's financial statements are very simple. It's like looking at a Rand McNally atlas. There's no hidden road."

But there have been plenty of twists and turns. The company's first major accounting shift came in 2000. Since the early 1980s, CA had double-counted revenues when it renegotiated multiyear contracts with corporations before they expired. After the new contract went into effect, CA would book the entire amount, even though that included revenues from the overlap period. The practice added $663 million to revenues in fiscal 2000, inflating the total by 9.7% and helping drive the stock to an all-time high of $75 per share in January, 2000. Because CA also took a $663 million expense to balance out the double-counting, though, the accounting treatment didn't affect its earnings. In May, 2000, following a recommendation by its new auditor, KPMG LLP, CA began subtracting previously counted revenues from its new tallies when it booked renegotiated contracts--the way competitors had always handled things. CA's change retroactively chopped $2.56 billion off revenues it had reported over a five-year period.

Is there anything illegal about the old way of accounting? The feds aren't talking. But some stock analysts who have studied CA's books wonder what the fuss is about. "If this is what they're looking at, I don't know that they'll find anything wrong with it," says Morgan Stanley analyst Joe Farley.

When you drill down deeper, though, the way CA's sales force handled these contracts raises questions about whether it artificially boosted its numbers. According to several former CA sales people, managers pressured them to reopen multiyear maintenance contracts with customers and craft new agreements that included lots of new software. The former employees say CA sometimes essentially threw software in for free. But in the resulting contracts, software made up a significant piece of the total price, and since software license revenues were largely recognized up front, this practice jacked up revenues and profits in the short term. A "gray area," according to Prudential Securities Inc. analyst John McPeake, is whether CA's practices inflated short-term revenues and profits at the expense of future performance without reflecting that in the financial reports. "I'm concerned that they were too aggressive," says McPeake.

CA denies it pressured employees to do anything improper to boost revenues. It says, though, that there may have been cases where salespeople, acting on their own, structured deals to boost commissions.

The company made an even more drastic change in accounting shortly after CEO Sanjay Kumar took over. Starting in December, 2000, CA began to recognize most software-license revenues in equal annual increments over the life of multiyear contracts. The stated purpose: to smooth out earnings from quarter to quarter. Critics, however, say it was intended to obscure the fact that CA's business was in decline.

No matter what the motivation, the effect was dramatic. The company's revenue declined from $6.09 billion in fiscal year 2000 to $2.96 billion in fiscal year 2002. Net profit of $696 million in fiscal year 2000 dropped to a net loss of $1.1 billion in fiscal year 2002. And Kumar compounded the confusion. Initially, for communicating with investors, he adopted pro forma accounting that recalculated past revenues and earnings as if they were based on the new accounting system. Some analysts complained, saying they didn't trust the pro forma numbers. Ultimately, CA backed off.

The company's finances remain murky. Because many of CA's long-term contracts have yet to be renewed under the new accounting principles, it could be two to three years before investors can tell for sure what the company's longer-term growth rate and profit margins will be.

With all of its accounting changes, CA has chased investors away. And if the feds file charges, the numbers at CA could be stirred up yet again.

By Steve Hamm in Islandia, N.Y.

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