Their Faith's in the Numbers
CA confident of vindication in accounting controversy
March 4, 2002
ON A CLEAR OCTOBER MORNING in New York two years ago, Sanjay Kumar stood
before a gathering of Wall Street analysts at The Plaza hotel to trot out
his "new business model."
Kumar, then only several months on the job as chief executive of Computer
Associates, spoke with conviction and intelligence as he explained that CA
would begin charging for its software the way power companies charge for
electricity - month to month. It would institute a new "pro-forma
pro-rata" accounting method to accompany the new business model, resulting
in significant changes to the way investors view its operating results.
Comparing the old numbers to the new, he said, would be like comparing
"apples to rib-eye steaks."
When he finished his presentation, Kumar showed admirable patience walking
analysts and reporters through many questions.
It's a job that continues.
And one that is not getting any easier.
In the face of two federal probes into its accounting practices, Computer
Associates last month said it is standing by its controversial accounting
methods. It's a bold statement of conviction given all the company has
endured over the past two years.
"While we'd be the first to admit that we could always do better in terms
of explaining our shift to ratable accounting...it is clear that
accounting professionals agree that our GAAP-compliant ratable accounting
is an appropriate and transparent methodology," Kumar said last month in a
conference call confirming the federal probes.
It's not the first time the new accounting methods have plagued the
Islandia company. (Indeed, the day Kumar introduced the new business
model, a New York Times story critical of its accounting ran under the
startling headline, "Computer Associates Still Lacks Credibility.")
An expensive proxy battle last year by Texas tycoon Sam Wyly, who
ridiculed the company for its "phony" accounting, took sharp aim at the
pro-forma accounting methods. CA fended off Wyly's efforts, at a cost of
more than $10 million.
Last April, The Times accused the company of using "accounting gimmicks"
to mask "a mirage" of past revenue growth. Pro-forma, the paper charged,
was a means to disguise the revenue falloff. A day after the story
appeared, Kumar held an early morning conference call that made no direct
reference to the Times story, focusing instead on a detailed explanation
of its new accounting.
Last week, CA shareholder Jack McBride filed a suit accusing CA of
securities fraud through a scheme to hide "a disastrous drop in revenue."
CA blasted the suit, based largely on the Times story, as a "cobbled
together" effort that used media reports that are inaccurate or
misleading...We intend to defend ourselves vigorously," the company said.
While it will be up to federal authorities and the courts to determine the
veracity of the claims about CA's accounting, one lesson for any company
pondering a complex accounting change is clear: Keep it simple.
Forget for a minute the possible implications of the federal probes and
the shareholder suit. The fact that a company's accounting could be
debated in investment circles raises red flags, observers say.
"There are only two possible reasons why experienced analysts wouldn't be
able to understand a company's financial reports," said Gary Lutin, an
investment banker at Lutin & Co., who tracked the company during last
year's proxy fight. "One is that management doesn't have the information
needed to understand the business themselves. The other is that management
has the information but doesn't want to show it to investors."
In a conference call with analysts in January 2001, it became clear that
Wall Street analysts, even those closest to CA, were having problems
relating the new numbers to those they'd relied on in the past. Past
results under generally accepted accounting principles sank under the new
business model. That was because CA created a new line item called
residual value, where it pooled future subscription revenues. But new
pro-forma numbers, which assumed that CA and its recently acquired
companies had been operating under the new model for years, drew
skepticism because CA had, in fact, not been operating under that model
for several years.
"The real issue is management's continuing failure to provide financial
reports that satisfy accepted standards," Lutin said. "I can't think of
any reason why CA's management would continue presenting pro-forma numbers
without reconciliations to GAAP [numbers], or why CA's directors would
But CA has gone out of its way over the past year to stress GAAP numbers
first, and to present pro-forma figures as a "supplemental" view of its
Those who track CA suggest the ride of the past year is one investors
should get used to.
"For better or worse, controversy is not new to CA," securities firm SG
Cowen said in an eyebrow-raising report last week. "Over the past 15
years, we've seen the stock fall sharply from time to time due to either
weak fundamentals or accounting/perception problems. And while we'd rather
not go through the anguish, each of these declines has created a
significant buying opportunity ... "
Assuming in this latest case the company is guilty only of gross
misunderstanding, it appears Kumar and the company will nevertheless
continue to have a lot of explaining to do.
Copyright © 2002,