29, 2001, Sunday
MONEY AND BUSINESS/FINANCIAL DESK
A Software Company Runs Out of Tricks; The Past May Haunt Computer
By ALEX BERENSON ( Chronology ) 3476 words
LOOMING above the Long Island Expressway in Islandia, N.Y., the
steel-and-glass headquarters of Computer Associates certainly looks
After all, since 1976, Computer Associates has grown from a
three-person start-up into the world's fourth-largest independent
software company. Led by Charles B. Wang, its chairman and founder, it
has bought hundreds of smaller rivals, gaining a choke hold on an
obscure but lucrative corner of the industry. Today, it has 18,000
employees and is the dominant supplier of mainframe utility software,
the programs that help big computers run smoothly.
Along the way, Computer Associates has become a financial giant and
made Mr. Wang very rich. In the fiscal year ended in March 2000,
Computer Associates reported profits of $696 million on sales of $6.1
billion, five times the sales and profits it posted a decade earlier.
It has a market value of $20.3 billion, more than Nike or Lockheed
Martin. Mr. Wang, who came to the United States from China at the age
of 8, owns shares and options worth almost $1.1 billion, according to
the company's most recent proxy. Last year, Mr. Wang and Sanjay Kumar,
the company's chief executive, bought the New York Islanders hockey
team for $187.5 million.
But much of the growth that has enriched Mr. Wang was a mirage,
according to more than a dozen former employees and independent
Computer Associates, they say, has used accounting tricks to
systematically overstate its revenue and profits for years. The
practices were so widespread that employees joked that C.A. stood for
''Creative Accounting,'' and that March, June, September and December,
when fiscal quarters end, had 35 days, giving the company extra time
to close sales and book revenue.
While reporting rising revenue and profits to Wall Street, Computer
Associates has infuriated clients with high prices and poor technical
support. Its heavily marketed efforts to diversify out of the
mainframe business have been a painful failure, former employees and
Over the years, it has gained a reputation as a callous employer
that dismisses workers without warning while top executives take home
eight- and sometimes nine-figure pay packages. And it has so angered
I.B.M., which makes most of the mainframes that its software supports,
that I.B.M. is accusing Computer Associates of charging too much for
its products. I.B.M. is now developing its own rival software.
Now, Computer Associates' past may have caught up with it.
The company declined to make Mr. Wang or Mr. Kumar available for
comment and asked that questions about its accounting practices be
sent in writing. It then declined to answer more than a dozen
questions sent by e-mail.
Big acquisitions were key to the accounting maneuvers, employees
and analysts say. And after two decades of buying competitors,
Computer Associates has essentially exhausted the pool of takeover
As measured by standard accounting rules, Computer Associates'
sales have fallen almost two-thirds over the last six months. To cover
that, the company has begun presenting its financial results in a way
that confuses even the Wall Street analysts who follow it.
The company's stock has been strong this year. But within the
information technology industry, its problems are no secret. ''C.A.'s
got a particular challenge ahead of them,'' said William Snyder of the
Meta Group, a 600-employee consulting company that advises companies
about information technology. ''They have two to three years to turn
To be sure, complaints about Computer Associates' prices and
customer support have been around almost as long as the company, and
it has always outlasted its detractors. But if former employees'
claims are accurate, the company faces a serious crisis.
These employees declined to speak for the record. The company has a
well-deserved reputation for having a fierce legal department. Since
the beginning of 2000, it has been either a plaintiff or defendant in
three dozen federal lawsuits, on issues ranging from commission
disputes to discrimination claims.
But, given anonymity, people who worked in sales, accounting and
marketing units at Computer Associates explained how the company
inflated its reported revenues in a way that made it look as if new
products were selling better than they were. The company's public
financial statements support their claims, they said.
The proof, in other words, is in the numbers.
ON April 16, Computer Associates reported another banner quarter.
''New Business Model Rules; Q4 Rocks,'' it said proudly in a news
release outlining its results for the three months ended March 31. The
company appeared untouched by the slowdown in technology spending that
has hurt other big software companies like Oracle.
Computer Associates said that on a ''pro forma, pro rata'' basis,
its revenue had risen to $1.44 billion for the quarter, from $1.39
billion in the period a year earlier. Profits were 47 cents a share,
it said, up from 39 cents a share.
During a conference call later, Mr. Kumar, the chief executive, and
Ira Zar, the chief financial officer, accepted analysts'
''Today really is a great day for us at Computer Associates,'' Mr.
He attributed the company's strong pro forma results to a new
software licensing model that it unveiled with great fanfare on Oct.
25. The company promised that its ''new business model'' would allow
it to offer customers more flexible contract terms, including
In addition, the new model would help Computer Associates by giving
it a more predictable revenue stream, the company said. Previously, it
struggled each quarter to close enough large deals to meet Wall
Street's expectations and discounted its software heavily as the end
of each quarter approached.
''The new business model turned out to be a competitive advantage
for us,'' Mr. Kumar said in the conference call. Wall Street agreed.
Over the next three days, the company's stock soared $7.41, to $37, a
gain of 25 percent. After falling steeply from its January 2000 high
of $75 to $18.13 in December, the stock has rebounded strongly this
year, closing on Friday at $35.25.
But the last line of the April 16 news release told a different
There, Computer Associates reported its revenue and income
according to ''generally accepted accounting principles,'' the
standard that companies are required to use in filings with the
Securities and Exchange Commission to calculate results. By those
rules, revenue fell almost 60 percent, to $732 million, from $1.91
billion. After earning a profit of $1.13 a share, or about $700
million, last year, the company lost 29 cents a share, or about $175
million, this year.
The divergence followed an equally big gap in the company's quarter
ended Dec. 31. For that period, the company reported pro forma revenue
of $1.4 billion and profits of $247 million, while by the stricter
standards it had revenue of $783 million and a loss of $342 million.
Computer Associates is not the only company to highlight pro forma
results -- which offer investors an alternative, usually more
favorable, way to look at results -- and to play down standard
figures. Even so, its last two quarterly reports were extraordinary.
Many companies that make use of pro forma accounting offer a detailed
road map connecting those figures to standard results. Computer
Associates did not. Nor have analysts been able to decipher how the
company is reporting its numbers.
''The pro formas are very difficult to fathom,'' said Norma
Schroder of Gartner Dataquest, a leading technology consulting firm.
''I've spent many hours with the financial statements, and I'm still
having problems understanding it.''
The company says its pro forma numbers more accurately reflect its
results now that it has changed its licensing terms. But customers and
competitors say the company continues to use old sales tactics and to
offer old contract terms.
''I have not heard anything that we would be paying monthly,'' said
Andy Olivenbaum, who is negotiating a new license for Florida's
Northeast Regional Data Center, which processes records for the state.
''Certainly out in the field they're still selling the way they
always sold,'' said Bob Beauchamp, president and chief executive of
BMC Software, a rival mainframe software company. ''To my knowledge,
we have not run into this, quote, new model.''
Former employees and analysts have a very different explanation for
the company's effort to focus Wall Street on its ''new business
model.'' After years of inflating revenue and profits, Computer
Associates has finally run out of accounting maneuvers, they say. Now,
they add, it hopes to persuade analysts to ignore its standard
accounting results while it unravels the mess it has created.
UNDERSTANDING how Computer Associates is said to have pumped up its
revenue requires a bit of background about the way software is sold.
Big software companies usually offer clients software for a large
initial fee that enables them to use it for a year, followed by annual
fees to continue using it and receive product upgrades and technical
support. The annual fees are usually 15 to 20 percent of the first
year's fee. Customers can also sign a long-term contract and spread
the initial fee, plus the annual fees, over the term of the contract.
The fees increase along with the power of the computers used to run
For accounting purposes, the crucial issue that determines whether
Computer Associates, or any software company, can immediately book the
fees as revenue is whether the fees are classified as license or
maintenance charges. (When the fees are supposed to be paid is nearly
irrelevant, accounting experts say.)
If the fees are called maintenance, then accounting rules require
software companies to book them a little at a time over the life of
the contract. But if they are considered license fees, then under some
circumstances the companies can book them immediately, even if they
are to be paid over a period of many years.
By categorizing fees as related to licenses, instead of
maintenance, Computer Associates could inflate its revenues in any
given quarter, at the expense of future quarters. And, subject to
outside auditors' approval, it had considerable discretion over
whether to classify fees as license or maintenance.
For at least a decade, the company has taken full advantage of that
discretion, former employees say. When Computer Associates bought
other software vendors, it would try to persuade their existing
customers to ''reroll,'' or extend, their license and maintenance
agreements for as long as 10 years. It then classified most of the
fees from the extended agreements as new license revenue and booked it
Other software companies are more conservative in the way they
split license and maintenance fees. For example, BMC Software
classifies all the fees it charges after the first year of long-term
contracts as maintenance fees, and books them over time.
''There's a dirty little truth about the mainframe business,'' said
a former Computer Associates executive who worked in its interBiz
division. ''There's not a whole lot of new mainframes going in, so a
lot of what's being booked as new revenue is taking an existing
contract that's expiring and adding years on to it. It's rerolling a
More than a dozen other former employees confirmed that account.
''What C.A.'s going to do is say, 'We're going to give you a long-term
deal here,' '' another former executive said. ''They hire young, cute
girls to basically resell maintenance contracts.''
Sometimes, that tactic backfired. George Allen Papapetrou, a
systems programmer for the school board of Alachua County, Fla.,
recalled that about six years ago, the company sent a saleswoman who
was ''a very attractive young woman, but she knew nothing about
mainframes.'' Mr. Papapetrou added, ''Most of us are geeky-type
people, so we'll appreciate the looks, but we certainly don't
appreciate the lack of knowledge. I felt sorry for her.''
REROLLS were not Computer Associates' only accounting maneuver,
former employees and analysts say. Wall Street, which knew mainframes
were steadily losing market share to ''client server'' systems made by
companies like Sun Microsystems, wanted the company to prove it could
compete in that arena. In that battle, Computer Associates' most
important software product was Unicenter, later called Unicenter TNG,
which in theory lets companies map and control their entire computer
Computer Associates had difficulty winning clients for Unicenter.
In part, its problems stemmed from its history of buying smaller
companies, firing their support staffs and raising fees for customers
who wanted to buy more powerful computers. Those moves increased
revenue and profits but alienated customers.
''I don't think it's any secret that a lot of us, especially in
mainframe stuff, are not C.A. fans,'' said Doug Fuerst, a software
consultant in Brooklyn whose clients have included big financial
services companies. At technology conferences, when people were asked
if they were trying to drop ''one or more C.A. products, probably 95
percent of the hands go up in the room,'' he said.
Mr. Papapetrou said the Alachua school board now uses nine Computer
Associates programs, compared with 13 four years ago, paying about
$20,000 a year, down from $30,000. ''We've been steadily trying to
eliminate C.A. products,'' he said.
Unicenter has another drawback. Its complexity makes it difficult
to install, and most companies are not able to operate it
successfully, said Donna Scott, a Gartner analyst. Both inside and
outside Computer Associates, Unicenter is derisively called ''shelfware,''
or software that is bought but never used.
In fact, while Computer Associates sometimes issues news releases
highlighting Unicenter clients, it is hard to find major companies
using it. Those that Computer Associates has publicly identified
include Bradlees, the discount chain that is now being liquidated, and
the New Pig Corporation, in Tipton, Pa., which Computer Associates
calls ''a leading provider of cleaning products and maintenance
solutions for industrial facilities.''
Unicenter and Jasmine ii, another product that Computer Associates
has advertised heavily, ''are pretty hard to find in the wild,'' said
Herbert VanHook, senior vice president at the Meta Group.
Yet Computer Associates has steadily reported increases in its
Unicenter revenue. In fiscal 1999, it said in an S.E.C. filing that
Unicenter accounted for one-fourth of its overall revenue. By last
year, Unicenter and other nonmainframe products accounted for half the
company's overall contract revenue, it said.
It may appear paradoxical that customers would pay for software
that did not work. The explanation, former employees and analysts say,
is that the company often offered Unicenter free in the maintenance
rerolls it offered. In deals called ''wrap and rolls,'' it would then
allocate a portion of the revenue to Unicenter, enabling it to show
sales growth to Wall Street.
''Sometimes the deals that were made, if you're using these
products, we're going to throw in this for free,'' Ms. Scott said.
''It doesn't mean it's going to get implemented.''
All of this explains a puzzling trend in Computer Associates'
financial statements. At most big software companies, maintenance fees
account for more than one-quarter of overall revenue. For example,
SAP, which has just passed Computer Associates to become the
third-largest independent software company, reported maintenance
revenue of 485 million euros, or about $440 million, nearly one-third
of its overall revenue, for the three months ended March 31. And, not
surprisingly, maintenance fees generally rise along with license fees.
Indeed, several years ago, Computer Associates' company results
were in line with industry standards. In 1992, it reported maintenance
fees of $585 million, about 39 percent of its overall revenue of $1.51
billion. The next year, overall revenue climbed 22 percent, to $1.84
billion, while maintenance revenue rose 15 percent, to $672 million.
Then something changed. Over the next seven years, overall revenue
skyrocketed, as the company made several major acquisitions. In fiscal
2000, its overall revenues reached $6.1 billion, more than triple the
level seven years earlier.
Yet over the same period, maintenance revenue grew only 30 percent,
to $877 million. As a result, in fiscal 2000, maintenance accounted
for only 14 percent of revenue.
Put another way, Computer Associates' maintenance rose only $200
million in seven years, even though two companies it bought over that
span -- Legent and Sterling Software -- had each reported more than
$200 million in maintenance revenue in the last year they were
IT is not clear whether the way Computer Associates prepared its
financial statements broke any accounting rules. Both Ernst & Young,
which audited the company until 1999, and KPMG, its current auditor,
declined comment on Computer Associates' practices.
But there is no doubt that rerolls and wrap-and-rolls shifted
future fees into current reported revenue, pumping up the present at
the expense of the future. And once the company had rerolled an old
contract, it could not reroll it again for several years. So to keep
reporting growth, employees say, the company needed to find a steady
supply of new contracts to turn over.
So the company began buying ever-bigger companies. In 1995, it
bought Legent for $1.8 billion in cash, at the time the largest
takeover in the history of the software business. The next year, it
acquired Cheyenne Software for $1.2 billion in cash. In July 1999,
Computer Associates bought Platinum for $3.5 billion in cash. And last
year, it picked up Sterling for $4 billion, its biggest acquisition
Now Computer Associates has few targets left. Of remaining
independent mainframe software companies, the only ones of any size
are Compuware and BMC. Both are smaller than Computer Associates, and
mainframe users, who say Computer Associates already has a monopoly in
many products, would object if it tried to buy either one.
Its core franchise, meanwhile, faces a powerful challenge from
I.B.M., which says Computer Associates is hurting its sales of new
mainframes. Computer Associates' fees rise as its clients install
faster computers, so a company that buys new I.B.M. hardware must also
pay much higher fees for software that is sometimes decades old.
Other software vendors also raise fees when clients install new
hardware, but Computer Associates' price increases are excessive,
I.B.M. asserts, especially since the company provides little support.
After years of asking Computer Associates to cut prices, I.B.M. has
decided to develop its own utilities and compete head to head.
''In the last three years we've been systematically upping our
investments,'' said Steve Mills, head of I.B.M.'s software unit, which
has annual sales of $13 billion. ''This is our business that they are
JUST before midnight on Monday, July 3, 2000, as most Wall Street
analysts were enjoying a four-day holiday weekend, Computer Associates
announced that its revenues and profits would fall far short of
expectations. On Wednesday, July 5, when stock markets reopened for
trading, angry investors sent its stock down $21.63, or 42 percent, to
$29.50. The sell-off shaved more than $12 billion from Computer
Associates' market value.
Three months later, the company announced plans to switch to its
''new business model'' and discouraged analysts from judging its
results by standard accounting rules.
So far, Wall Street has complied. But as other companies have
found, investors are apt to punish companies if they learn that their
results are not what they seem.
CAPTIONS: Photos: Led by Sanjay Kumar, left, chief
executive, and Charles Wang, chairman and founder, Computer Associates
has grown enormously. (Kevin P. Coughlin for The New York Times)(pg.
1); Although they are hockey novices, Sanjay Kumar, left, and Charles
Wang decided to buy the New York Islanders last year for $187.5
million. (Kevin P. Coughlin for The New York Times)(pg. 11)
Chart: ''Pay for Performance?''
Top executives at Computer Associates have been richly rewarded since
1995, although the company's stock has lagged behind other software
companies and the broader market.
Change in value since 1995
MAY 21, 1998
Three senior executives receive 20.25 million shares worth about $1.1
billion. The grant prompts shareholder lawsuits, which are settled
when the executives return 4.5 million shares.
JULY 22, 1998
The company warns of poor results. Analysts wonder whether it knew of
the problem when the grant was awarded.
JULY 5, 2000
Another warning prompts a second big sell-off.
Graph shows S.& P. COMPUTER SOFTWARE AND SERVICES INDEX, COMPUTER
ASSOCIATES, and the S.& P. 500 INDEX figures for those dates.
(Source: Bloomberg Financial Markets)(pg. 11)
Chart: ''Mixed Signals''
Since 1992, revenue from licensing fees has grown sharply at Computer
Associates, but maintenance fees have not kept pace. As a result, the
company's share of revenue from maintenance fees is much lower than
that of other big software companies. Former employees say that is
because Computer Associates aggressively booked fees it would not
receive for several years as soon as it signed contracts.
AT SIMILAR COMPANIES shows the fiscal year 2000.
(SERVICE FEES NOT REPORTED SEPARATELY '92-'97)
(Source: Company reports)
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