Did Peregrine Bully Its Partners?

Internal e-mails suggest it may have pressured distributors to buy products they couldn't sell

Late last year, Peregrine Systems Inc. (PRGN ) looked formidable. The San Diego software company was heading toward a record year, with revenues exceeding $500 million. Peregrine was emerging as the leading maker of so-called asset management software, which helps large companies manage vast systems, from computer help desks and PCs to company cars. More than 5,000 companies, from Bayer (BAY ) to Panasonic, had snapped up its products, thanks in part to its aggressive sales force.

Far too aggressive, it turns out. The company goosed revenues by pressuring distributors and resellers to order more products than they believed they could sell quickly, without building up inventories, according to former distributors, resellers, and former Peregrine executives. "The sales channel became a dumping zone for Peregrine," says one former reseller.

The consequences have been disastrous. Peregrine announced in June that the $1.3 billion in revenues it reported over the past three years may have been overstated by as much as $250 million. This prompted Peregrine to seek Chapter 11 protection in September--the biggest software bankruptcy ever. Now, customers are waiting to see if a key software provider will survive, and the Securities & Exchange Commission is investigating possible accounting fraud.

Already, a spring investigation by KPMG LLP has found more than eight potential accounting violations, most related to distribution channel sales. KPMG says in an SEC filing that one potential violation was booking sales that either didn't take place or that resulted in returns that were not accounted for properly. It was this filing, pointing to possible fraud, that exposed the troubles at Peregrine and led to the meltdown. Peregrine execs say they have taken "decisive" action to address the problems.

Now, new details are emerging. E-mails obtained by BusinessWeek provide a look at Peregrine's relentless sales staff in action--promising concessions to a sales channel partner who agreed to buy $3 million worth of a product. In the midst of the worst tech downturn ever, Peregrine apparently attempted to sidestep a sales decline, foisting it instead on its distributors and resellers.

It wasn't just the accounting that went awry. Interviews with more than a dozen former employees and partners paint Peregrine as a badly mismanaged company. Peregrine made 14 acquisitions, including main competitor Remedy Corp., in three years, but failed to fully integrate the products or sales forces. Peregrine sales reps battled ferociously with each other for accounts. "Customers saw this going on," says one former sales executive. "That hurt our relationships with them." Some frustrated insiders referred to the company's two leaders, then-CEO Stephen Gardner and Chief Technology Officer Frederic B. Luddy, as "the two left feet," says one former executive.

Peregrine readily admits to management missteps. Luddy, who still works for Peregrine, agrees that the company's core products "were not as integrated as they could be." And CEO Gary G. Greenfield, who was brought in to clean up the mess, says: "We pushed our partners too hard." Gardner, who could not be reached for comment, resigned in May, when the company announced it was investigating accounting irregularities.

The worst problems were in sales. Channel partners say Peregrine's sales managers often strong-armed them into signing purchase orders for millions of dollars' worth of products long before customers were lined up, a practice known as stuffing the channel. Those who balked were sometimes told that they might be cut off from Peregrine's future offerings--a serious threat to some small resellers for whom Peregrine was a mainstay.

Stuffing the channel isn't illegal. But the KPMG filing says Peregrine improperly classified some unrealized revenue from products that were returned or not paid for as "acquisition costs" or "other." Returned products should have been subtracted from revenues. Unpaid accounts are supposed to be listed as bad debt. Hiding such costs in one-time charges can give investors a false picture of rapid sales growth. If true, "it looks like rampant fraud," says former SEC chief accountant Lynn E. Turner, after reading the KPMG filing. He's now director of the Center for Quality Financial Reporting at Colorado State University in Fort Collins, Colo.

In its filing, KPMG also points to evidence that Peregrine provided side agreements excusing channel partners from paying for orders. One possible example, uncovered by BusinessWeek, is a December, 2001, deal with Seattle distributor Rainier Technology Group Inc. Sources familiar with the transaction say Rainier was pressured into signing two purchase orders totaling $3 million for copies of Xanadu, a new package of Peregrine products designed for resellers to offer as a service to midsize companies.

Insiders say that technical problems held up Xanadu. In a March e-mail, obtained by BusinessWeek, Peregrine's vice-president for partner relations, David Roudebush, assured Rainier executives they would not have to pay Peregrine by the agreed-upon deadline. "Peregrine is not going to go after you," Roudebush's e-mail says. Rainier never paid, and asked to cancel the deal. But when Rainier executives requested copies of cancelled invoices, Roudebush refused, according to sources familiar with the transaction. Roudebush says the e-mails simply reflect his efforts to resolve the dispute in "an amicable way." He adds: "In reference to the other allegations. I have personally not conducted business with partners in this way."

It is still unclear whether Peregrine booked the transaction as a sale. Doing so would be a violation of SEC rules. Officials at Rainier declined to comment on any possible accounting violations at Peregrine.

CEO Greenfield is working furiously to salvage what's left of Peregrine's reputation. He tells jittery customers that he's refocusing on the flagship asset-management software. He has divested properties worth more than $400 million, including supply-chain management software that Peregrine took on in its acquisition binge. And the company promises customers a new, more integrated software package within 18 months. "We are confident about their ability to grow the products and support them," says Karen Stefanik, director of information systems for Bayer, a Peregrine customer.

Still, competitors are swarming. Peregrine's biggest rival, Computer Associates International Inc. (CA ), which has a reputation for brass-knuckled sales tactics, is targeting Peregrine customers. So far, CA says it has nabbed 25 accounts. Analysts predict new customers will stay away. "They've lost their credibility," says META Group Inc. analyst Michele Hudnall.

Greenfield remains confident. "Is our reputation tarnished? Maybe," he says. "But you can always polish silver again." Still, the allegations of management misdeeds will make it difficult for Peregrine to regain its former luster.

By Arlene Weintraub in San Diego

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