Computer Associates Probe Focuses on 1998, 1999 Revenue

Updated from 8:05 a.m. EDT

Shares of Computer Associates(CA Quote) dropped modestly Monday amid a report that federal investigators are examining a May 2000 accounting reclassification that eliminated more than $1.7 billion in prior years' revenue.

Shares of Computer Associates were down 46 cents, or 2.6%, to $17.10 in recent trading.

The investigation by the Securities and Exchange Commission and Justice Department is focusing on whether Computer Associates wrongly booked more than $500 million in revenue in 1998 and 1999, a time when three senior executives were enriched via payouts that were triggered by stock price milestones, The Wall Street Journal reported Monday.

Investigators are focusing on action taken by Computer Associates in May 2000 in which it said it "reclassified" $1.76 billion in revenue because of a change in the way it accounted for software leases. Under the change, disclosed in its 10-K annual report, earnings were unaffected because of a matching reduction in expenses.

The revision included hundreds of millions of dollars retroactively eliminated from revenue in the 14 months before a controversial May 1998 stock award to senior management -- including $513 million for the year ended March 1998, and some portion of the $587 million taken away from the following year.

An SEC spokesman said he could neither confirm nor deny the existence of the investigation. A Justice Department spokesperson could not be reached for comment.

In a statement Monday, Computer Associates said it changed how it classified revenue and expenses at the advice of its auditors. "We continue to believe CA has acted appropriately," the company said. "This change in presentation had no impact on reported earnings, earnings per share, or cash flows."

Indeed, under the reclassifications, earnings remained the same. However, the reclassifications reduced revenue -- which also weighs into investor considerations and stock price -- in both 1999 and 1998 by about 11%. According to SEC filings, CA's reclassification reduced 1999 revenue to $4.7 billion from $5.3 billion. The company's reclassification reduced 1998 revenue to $4.2 billion from $4.7 billion.

Meanwhile, under a controversial executive incentive program, the company's top three executives reaped $1 billion in stock after the company's shares closed above $53.33 for 60 days in May 1999. The company soon reported slowing demand, reclassified its revenue a year later and eventually reduced the award to 4.5 million shares in settlements of shareholder suits. Now investigators want to know why the company overstated its revenue for the period immediately preceding and following the stock grants, according to the Journal.

The retroactive decline in revenue also has been a topic in other shareholder class action cases against Computer Associates. At issue in both a shareholder case and federal investigations is whether Computer Associates booked 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, according to the Journal.

In its statement, Computer Associates said, contrary to the Journal report, new contracts superseding existing multiyear contracts were of great value, often including new products, increased capacity and additional benefits to the client.

Analysts who cover Computer Associates have long been aware of the reclassifications. Sarah Mattson, an analyst with RBC Capital Markets, said it does not appear as if Computer Associates did anything illegal or contrary to generally accepted accounting principles. She said before the reclassification, Computer Associates offset the double-booking of revenue when two contracts overlapped by offsetting the amount on its expense line.

"But optically by going back and having to explain it, it creates the perception of something strange," Mattson acknowledged. "The optics of it are not very positive. It looks bad."

Mattson characterized the latest scrutiny on the reclassifications as just "one more cautionary note," "one more reason for investors to stay away from the stock." Mattson has a sector perform rating on Computer Associates with above-average risk ratings. Her firm has done banking business with Computer Associates.