Checking It Twice

WorldCom's disclosure that it disguised nearly $4 billion in expenses to buoy earnings sent shock waves through an already fragile investor psyche, rocked by accounting irregularities at Xerox, Enron and Arthur Andersen, the auditor for Enron and WorldCom. In recent months, high-tech companies such as Global Crossing, Enterasys Networks, RSA Security, Critical Path, EMC and EDS also have grappled with financial reporting discrepancies.

The sharpened regulatory and media scrutiny of corporate America's books is forcing all companies,large and small, public and private,to ensure that their accounting practices are beyond reproach, according to industry executives and observers. Many solution providers say that although the scandals haven't pushed them to revamp their accounting policies, they are re-examining their record-keeping.

Brad Waugh, founder and managing partner at WatchHill Partners, a private solution provider based in Providence, R.I., said that at the start of the year his firm adopted a more conservative method of recording revenue. In the past, WatchHill recognized revenue when it completed project milestones, but now if the company doesn't get a customer signature at a given milestone, then the work isn't counted as revenue, he said.

"It's definitely something that causes me to pull the hair out of my head," said Waugh. "But if you take a look around, it's just the right thing to do."

The unraveling of the fast-and-loose rules that some IT companies used to recognize revenue during the late 1990s has stung a high-tech market already battered by the dot-com bust, Sept. 11 terrorist attacks and roller-coaster economy. So for solution providers, fair and accurate record-keeping is more than just a case of better safe than sorry. Price wars, a shrinking pool of business, longer sales cycles, project delays and cancellations, shorter-term engagements and a greater customer focus on return on investment have changed the amounts and timing of incoming revenue, solution providers say.

For instance, before the end of WatchHill's most recent quarter, one customer wouldn't sign off on completed work until another vendor finished the next phase of the project, Waugh said. So WatchHill pushed the revenue out to the middle of the next quarter, he said.

Some solution providers are working to clarify other gray areas. Padman Ramankutty, CEO of Bristlecone, Santa Clara, Calif., said categorizing consultants' work remains a big challenge. "A consultant builds a certain amount [of a solution, but he also does nonbillable work," said Ramankutty. "Getting the right granular detail going to the right buckets is always a challenge."

Recording income from IT consulting work should be straightforward: Revenue should be recognized at the time of consumption, Ramankutty noted. "In the past, the problem was we all got into projects of hundreds of thousands of dollars in value," he said. "You booked so much, but if you have only delivered $500,000 and 80 percent of the time is gone, you cannot assume the rest of it is going to come."

Alliance Consulting keeps a tight rein on its billing cycles, which gives the Philadelphia-based solution provider a clear view of its revenue picture, according to CFO Stephanie Cohen. "We run 60-day services to cash," she said. "Depending on the type of solution, we are billing biweekly or monthly. It's typically a monthly billing cycle and then a 30-day collection period."

A typical job for Alliance Consulting lasts four to six months, Cohen said. "Being a $100 million company, we don't have a lot of projects that span multiple years," she said. "We don't have the situation that some of these companies do, where they could amortize [projects over a long time."

In the current financial climate, a cautious approach to accounting is the only way to go, said David Rauktys, managing director at First Albany, a Boston-based investment research firm. That means CFOs of public and private companies have a responsibility to make sure the financial information they're presenting is transparent and consistent, he said.

"There's a policy decision that all companies have to make for how they will end up reporting revenue and what they will count as revenue. And in this kind of environment, it makes sense to be even more conservative than GAAP [generally accepted accounting principles," Rauktys said. "There will be no forgiveness two quarters from now for special charges or unusual events that are accounting-related. We're going to be in a very choppy environment," he added.

WatchHill CFO Harry Schult said that even though WatchHill is a private company, "we run it as if we are a publicly held company." Each quarter, WatchHill's internal audit committee meets with its auditor, Cap Gemini Ernst and Young, to ensure that the proper signatures accompany recorded revenue and time sheets back up expenses such as time and materials, he said.

Revenue recognition is often the key source of accounting problems, said Schult. "I've been in this business for a long time. It always comes back to haunt you in spades when it turns out you are doing things you shouldn't be doing just to make things look good at the time," he said.

Business models for most small and midsize services companies are relatively easy to understand, but revenue recognition over the life of a project remains an issue, Rauktys said. "Product-based vendors and telecommunications providers have more complexity in their income statements, and there's a lot more gray [area in how they can choose to account for things," he said.

President Bush and Congress are scrambling to develop tougher penalties to punish corporate financial fraud, including a proposal that would double maximum prison terms for those convicted of such crimes. And late last month, the Securities and Exchange Commission began requiring the CEOs and CFOs of 945 public companies with reported annual revenue of more than $1.2 billion to personally certify company financial reports. The SEC also has proposed the creation of the Public Accountability Board, which would oversee auditors of public companies and include accountants and investor representatives not associated with the accounting industry.

Some corporate executives already are taking an opportunity to reassure investors. For example, during a third-quarter earnings call on July 12, Accenture CEO Joseph Forehand told investors and analysts that he sent a letter to SEC Chairman Harvey Pitt to personally certify the New York-based integrator's financial statements,even though Accenture wasn't required to do so.

"We are committed as a company to be transparent in our accounting and to generate cash flow that backs up our earnings," Forehand said.

Also in the call, Accenture CFO Harry You defended New York-based Accenture's reporting practices for complex, multimillion-dollar outsourcing projects. "Completion of estimates for revenue and earnings for outsourcing deals have very accurately portrayed reality," You said.

Another big integrator, Plano, Texas-based EDS, found its business under a microscope earlier this month amid the unfolding debacle at WorldCom, one of its biggest clients. EDS CEO Dick Brown and other senior executives had an impromptu conference call with financial analysts on July 2 to defend the company, explaining that its pullout from a multibillion-dollar outsourcing contract with Procter and Gamble and layoff of 2,000 employees had nothing to do with its WorldCom relationship. "EDS is a solid company with a straightforward business model," a seemingly frustrated Brown said, assuring that EDS' accounting is aboveboard. He and EDS CFO James Daley will have to personally certify those claims in a statement to the SEC, under the commission's new reporting rule.

Though most solution providers won't have to worry about meeting such guidelines, many expect their own internal controls to speak for themselves. Edgewater Technology, for one, has implemented a "flash reporting mechanism" to review operating metrics such as billable hours and utilization on a weekly basis, said CFO Kevin Rhodes. The Wakefield, Mass., solution provider also holds weekly meetings to discuss the progress of projects and scrutinizes solutions as they are developed to head off any surprises such as project and revenue delays, he added. Two teams made up of business analysts, project managers and technologists,dubbed the Red Team and Green Team,conduct separate, in-depth reviews of everything from cash flow to the technology used.

"That's before the proposal even goes out the door," said Rhodes. "It's another type of internal control, and we find that it does very well in terms of hitting whether it's the right fit for the client."

Edgewater takes a conservative stance in revenue recognition, particularly with fixed-price projects, where income is accounted for on a percentage-of-completion basis, Rhodes said. "We actually don't take a profit on our fixed-price projects until we are at least 50 percent done," he said. "That helps us stay out of trouble."

Consistency in understanding and applying the rules is the key to revenue recognition, he added. "A lot of accounting rules are subjective, and revenue recognition is one of those. But you can't apply it one way one quarter because it's favorable to you and then the next quarter apply it a different way," he said.

Alliance Consulting doesn't do many fixed-price contracts, Cohen said. Instead, the firm emphasizes strong customer relationships and frequent communication between the finance team, the delivery team and the client, which allows for progress billing and continuous cash flow and avoids potential problems, she said. "Thus, if there were a customer issue, you would not have to wait until the end of the project [to find out," Cohen said. "This is a cash-flow business. A provider not doing a good job would see it in their cash flow."

Whatever the method, the bottom line is to go the extra mile to ensure that financial records and statements aren't a house of mirrors, since customers more than ever before will expect fair and honest behavior from their solution providers, said First Albany's Rauktys. "This is not a market environment where everyone is getting fabulously rich," he said. "So wouldn't it be nice to take pride in what you do and who you work with, and then sleep well at night?"

AMY ROGERS and ELIZABETH MONTALBANO contributed to this story.