After Enron, Tech Sector Accounting Under Scrutiny

Pricey payments for stock options that show up nowhere on income statements. Massive asset write-downs that help inflate future earnings. Specially designed profit reports that mask the ugly details.

These methods and more are hallmarks of a sector facing new demands for a return to the hefty revenue and profit gains that tech companies bragged about before the bust.

"I don't think there is an Enron type of story, but there are certainly a variety of very commonly used techniques in technology companies that exaggerate a company's profits," said Howard Schilit, director of a Maryland-based accounting watchdog, the Center for Financial Research and Analysis.

In some cases, investigations have already begun.

On Friday, telecommunications company Global Crossing Ltd. found itself the focus of two separate federal investigations after allegations of improper accounting. The company has denied improper accounting.

Among the chief complaints are rules that allow companies to keep the cost of stock options -- a popular compensation tool in the technology world -- off income statements.

A study by Bear Stearns estimated that earnings per share reported by the companies listed in the Standard and Poors 500 index would have been 6 percent lower in 1999 if the fair value of options were included.

When managers and executives are given loads of options, they have an interest in maintaining stock valuation growth even at the expense of the long-term health of the company, said David Rocker, who runs New York-based hedge fund Rocker Partners.

"The incentives of the managers are a function of the enormous options positions they have," Rocker said.

Even perfectly legal accounting maneuvers by technology companies have spooked investors, who hope to steer clear of future disasters.

Ariane Mahler, an analyst with Dresdner Kleinwort Wasserstein, said the most recent revenue report by Cisco Systems was inflated by deferred revenue--orders that were booked in prior quarters but not shipped.

She also said Cisco's gross profit margins were inflated because the company had sold some of the $2.25 billion worth of inventory that it wrote off last spring. An $858 million investment write-down the company took could boost future results, Mahler said.

Cisco and several Wall Street analysts have dismissed the allegations, saying the company's accounting complies with generally accepted principles. Cisco shares have fallen sharply over two days.

Schilit, director of the accounting research group, said the use of deferred revenue has tainted the income statements of some software companies. Sometimes a portion of software sales, such as maintenance or upgrades, can be stored as deferred revenue, and pulled from that pool of money to boost quarterly revenue statements in bust times, Schilit said.

By looking out for details about deferred revenue, investors can judge the quality of reported revenue for themselves.

"People begin to understand that the company's sales are really starting to struggle, so people will begin to catch on that quality of earnings and the quality of revenue is suspect," Schilit said.

Computer security and Web address provider VeriSign has been criticized for its affiliate relationships, which critics say amount to financing its own customers. Shares of Verisign recovered strongly Friday, after Bear Stearns analyst Chris Kwak wrote in a research note that the affiliate relationships were not a cause of concern.

A Verisign spokesman said the company has regularly discussed details of its affiliate programs.

Motorola , Nokia, and other telecommunications companies have also boosted sales by loaning money to customers in an approach called vendor financing.

The process has not always worked out for the best. Motorola and Nokia, the world's two largest mobile telephone makers, have filed a $3 billion lawsuit against one such recipient, a Turkish wireless carrier, alleging fraud. The company, Telsim, has denied the charges.

Software company Computer Associates faced strong skepticism last year for its accounting. The company, as well as some Wall Street analysts, have stood by the methods.

Many of the major technology companies are believed to have tweaked their numbers in order to meet Wall Street expectations, or at least look better, industry experts said.

International Business Machines includes income from its pension fund in its earnings reports, for instance.

And Cisco, which maintains it is conservative in its accounting, had earned a reputation by beating Wall Street estimates by a penny per share consistently, quarter after quarter, until last last year.

But with the Enron collapse putting accounting in all sectors under the microscope, technology companies can be sure investors will be watching them closely. (additional reporting by Ben Klayman in Chicago and Deepa Babington in New York)

REUTERS

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