Computer Associates' Revenue
Is Probed by Federal Officials

Federal authorities are trying to determine whether Computer Associates International Inc. wrongly booked over $500 million in revenue in its 1998 and 1999 fiscal years as part of a scheme to enrich the company's senior managers.

The Computer Associates probe, which is being conducted jointly by the Justice Department and the Securities and Exchange Commission, is one of many in which the government is examining the revenue-recognition practices of leading companies. Last week, Computer Associates acknowledged that the investigation had widened to include subpoenas to third parties. Its accountant for the 1998 and 1999 fiscal years, Ernst & Young LLP, said it has received such a demand and was cooperating with authorities.

Rising revenue was an important part of the logic that propelled Computer Associates shares on an upward arc in the 1990s, as the company appeared to be growing faster than rivals in selling software to big corporate customers. In May 1998, because the shares had reached a trigger price of $55.13 and stayed there for a sustained period of time, the company's three top managers -- Charles Wang, then its chief executive and now the current chairman; then-President Sanjay Kumar, who is the current CEO; and head of research Russell Artzt -- received a special incentive stock award then valued at $1 billion. Today, the stock trades at about $18.

Now, investigators want to know why the company overstated its revenue for the period immediately preceding and following the stock grants. They are focusing, among other things, on a little-noted action the company took in May 2000 to shave $1.76 billion, or more than 10%, off the revenue it had previously reported for the three fiscal years that ended in March of that year. The downward revision, made when the company filed its 10K annual report with the SEC, included hundreds of millions of dollars retroactively taken away from the top line in the 14 months before the May 1998 stock award to the senior management -- including $513 million for the year ended March 1998, and some portion of the $587 million taken away from the following year.

Earnings were unaffected by the revision, which the company refers to as a "reclassification," not a restatement, as the lost revenue was offset by a commensurate downward revision in expenses. In a footnote to the 2000 annual report, the company attributed the revision to a change in the way it accounted for software leases, but no further explanation could be found in the company's disclosure documents. Computer Associates declined repeated requests in recent days to elaborate.

The retroactive decline in revenue has also been a central topic in a shareholder class action against Computer Associates in U.S. District Court in Central Islip, N.Y., near its headquarters in Islandia, N.Y. In that case, plaintiffs have alleged revenue was boosted to help Messrs. Wang, Kumar and Artzt receive their award, some of which they were later forced to give back as part of a separate legal action. The plaintiffs' theory in the Islip case, also being explored by federal investigators, is that Computer Associates was routinely booking too much software licensing revenue in long-term contracts before it received the money -- even though many of the contracts were canceled before their term ran out and replaced by contracts of lesser value.

In a statement Sunday, Computer Associates said it intends "to defend against unwarranted allegations in court," but otherwise declined comment on the lawsuit. It has previously said there is nothing wrong with its accounting.

Most of the court record in the shareholder's lawsuit -- including depositions from Messrs. Wang and Kumar -- has been sealed. But transcripts of arguments between the two sides over pretrial matters indicate that the revenue revisions were prompted by its auditor, KPMG LLC, which replaced Ernst & Young as the company's accountant in June 1999. In early 2000, KPMG made a presentation to Computer Associates executives expressing concern about revenue recognition, the transcripts indicate, in an account supported by people familiar with the matter.

The KPMG presentation was detailed and had been prepared using PowerPoint software commonly used to create a computerized type of slide show for displaying charts and figures, plaintiffs say in the lawsuit. But Messrs. Wang and Kumar, in their sealed depositions, have given testimony saying they don't recall any KPMG concern over revenue booking, according to comments in the transcript from both sides and the presiding federal magistrate. A KPMG spokesman declined to comment on the matter.

In arguments before the judge hearing the civil case, the company's outside lawyers at Solomon, Zauderer, Ellenhorn, Frischer & Sharp have portrayed Messrs. Wang and Kumar as arm's-length managers who only casually reviewed regulatory filings such as 10K and 10Q annual and quarterly reports, and left the complex details of licensing accounting to subordinates in the finance department.

Last week, acting on a motion by Computer Associates, the magistrate ordered a further, more restrictive sealing of documents in the case, including portions of certain court transcripts already reviewed by The Wall Street Journal. The class action, expected to go to trial by year's end, is being pursued by two New York firms that specialize in shareholder suits -- Milberg, Bershad, Hynes & Lerach LLP and Stull, Stull & Brody.

The revisions contained in the 2000 annual report covered audited results for fiscal 1998 and 1999 and also made changes in the previous, unaudited results the company had reported in its press release for the 2000 fiscal year. For fiscal 1998, for example, revenue was marked down to $4.21 billion, some $513 million, or 11% less, than the $4.72 billion the company had previously reported. In announcing the original 1998 results in May 1998, Mr. Kumar announced "record" revenue and earnings that he attributed to "strong worldwide demand for CA software." In fiscal 1999, the downward adjustment totaled $587 million, also about 11.2%; and the $663 million taken off in 2000 amounted to a 9.8% reduction.

In July 1998, Computer Associates stock climbed above $60 a share. But later that month, Mr. Kumar warned that the effect of Asian economic turmoil and year-2000 computer-bug fears "leads us to believe that our revenue and earnings growth will slow over the next several quarters." On July 22, Computer Associates shares took a hit, dropping to $39.50 from $57 a share.

In October 2000, Computer Associates adopted new software-licensing accounting. Beginning in October, it said it would begin booking software leases under a "radical" new "business model" built around a "subscription-based" method for selling its products under shorter-term contracts. The company said the new method would help both customers and pressured sales agents.

Write to Jerry Guidera at jerry.guidera@wsj.com²

Updated May 20, 2002 1:05 a.m. EDT