PeopleSoft hopes to end numbers flap

The enterprise software maker's shares have been ground down in recent weeks over accounting worries about Momentum. This isn't the first time rumors have troubled the stock. In July, a hedge fund partner raised questions about the company's accounting practices and then quietly retracted his statements.

With the Securities and Exchange Commission targeting accounting abuses in light of Enron's meltdown, PeopleSoft will most likely have to clear the air about potential accounting issues even though the company is expected to report a strong fourth quarter with earnings of 16 cents a share, according to First Call.

But questions about "cooked books" and "tricky accounting" have deluged message boards on Yahoo and The Motley Fool ever since a Dec. 31 Bloomberg News article was published. The story noted that without certain accounting practices in regard to Momentum, which are now illegal, PeopleSoft would have lost money last year instead of reporting a 13-cent-a-share profit.

The article set speculation about an SEC investigation aflame with vague allusions to Enron, though no known investigation is taking place. The stock of diversified energy company Enron plunged to $1 per share last month as the SEC began digging into its accounting irregularities.

The flame was fanned again when a Forbes article titled "PeopleShell?" hit newsstands around Jan. 14, criticizing the company for creating a "shell" in which to hide expenses.

PeopleSoft says the articles are much ado about nothing.

"There's no new news here," said PeopleSoft spokesman Steve Swasey. But the perception problem is real; on Jan. 2 PeopleSoft stock declined as much as 5 percent from its usual $40 in response to the Bloomberg article. The stock recovered slightly, going as high as $41, before sinking to around $36 a share after the Forbes article was released.

Wall Street generally agrees with the company's stance, but it has a more complex take on the accounting issue.

"This has all been fully disclosed, but the other issue here is, this is very aggressive accounting," said Bruce Lupatkin, portfolio manager at hedge fund North Bay Partners.

Here's what happened: In January 1999, PeopleSoft spun off Momentum Business Applications, a company of one employee, to work on its new software product. Momentum then became a customer when it "hired" PeopleSoft's programmers to write code for that product.

Thus, PeopleSoft managed to record the research and development expenses for its signature product, PeopleSoft 8, as revenue coming in from Momentum. When the work was done, and the software had been created, PeopleSoft then had to pay Momentum royalties.

The Financial Accounting Standards Board's task force decided in May 2000 that companies aren't allowed to use spinoffs to fund research and development, but the practice was legitimate at the time PeopleSoft engaged in it.

"It was a smart idea and it was good for investors. It was the right thing to do at the time," Swasey said.

Most analysts agree that while they don't care for the accounting practices, any risk to investors is now in the past.

"Two years ago it would have been a concern--whether the company can really make a product or not," said Aziz Hamzaogullari, senior technology analyst at Evergreen Investments. If PeopleSoft's new software had been a mess, its accounting could have gotten it into dire straights.

Momentum is paying off
But all that money the company was able to funnel into R&D thanks to its controversial accounting has been paying off. PeopleSoft has been faring well with the core product that came out of Momentum, PeopleSoft 8, and the results are bound to show in the company's fourth-quarter results Jan. 24, according to analysts.

PeopleSoft 8 leapfrogged competitors such as Siebel Systems, Oracle and SAP by offering the first major collection of Internet-based corporate software. There are two components to the software: PeopleSoft 8 ERP, or enterprise resource planning, software that ties together clients' tasks such as accounting and supply chain management, and PeopleSoft 8 CRM, a customer-relationship management product.

The company's fourth quarter is expected to be evidence of that payoff.

"We believe the company will report solid fourth-quarter results, with the potential to deliver upside to our estimates of revenues of $531 million and earnings per share of 16 cents," said U.S. Bancorp Piper Jaffray analyst Jon Ekoniak, whose revenue estimate is even higher than Wall Street's consensus of $521 million, according to First Call.

"If PeopleSoft tops estimates, and I think they will, analysts will stay in love with it and people will stop asking questions," said Bill Schaff, fund manager for the Berger Information Technology Fund.

The only concern about the company's financial performance is for 2002; at least one skeptic predicts the company will miss estimates.

In a list of "Top Investment Ideas (and one short sell) for 2002," WR Hambrecht named PeopleSoft the "short" of the year. Short selling is a practice in which investors try to profit by betting a stock will fail.

"The company will have difficulty meeting current consensus estimates for 2002, and therefore, we believe the stock price is vulnerable," the report said, citing concerns about PeopleSoft's ability to keep increasing revenue from its PeopleSoft 8 product in a "difficult environment for closing deals with new customers."

Analyst Rich Peterson, who covers PeopleSoft for WR Hambrecht, did not return calls for comment.

Ekoniak's estimates for 2002 also put the company slightly below Wall Street's estimates. Ekoniak recently raised his 2002 estimates, but he predicts earnings of 66 cents a share and revenue between $2.16 billion and $2.20 billion. That's still low compared with First Call's consensus estimate for earnings of 72 cents a share and revenue of $2.21 billion.

Nevertheless, Ekoniak was upbeat about PeopleSoft, which he rates "outperform," and said the company's business fundamentals are improving vis-a-vis Oracle and SAP.

What's all the fuss about?
If the company's products are doing well, and Wall Street is expecting a strong quarter, what's the concern? Could PeopleSoft really be an accounting Frankenstein, on its last legs like Enron right before the fall, or is it just a victim of the change in accounting rules, maligned on Internet message boards by short sellers trying to make a fast buck?

The answer is a little more complicated than that. It lies in a little attitude problem on Wall Street, according to analysts.

"Wall Street has this attitude, 'It doesn't matter till it matters,'" said North Bay Partners' Lupatkin, who compared PeopleSoft to dot-com companies. "Analysts knew (dot-coms) didn't have a business model," he said, but that didn't stop them from recommending the stocks until the prices actually started to crash.

And judging by the flurry of activity on message boards, PeopleSoft's accounting is suddenly starting to matter now that the company may be about to repurchase Momentum.

A provision in PeopleSoft's spinoff of Momentum gave it the option to repurchase the company. Analysts now assume a repurchase is imminent, because if PeopleSoft doesn't make a move, it will have to keep on paying Momentum royalty fees, which at some point will become more expensive than the acquisition cost.

As if that weren't enough incentive to purchase Momentum soon, in mid-February, the minimum price of purchase goes up, from $90 million to $92.5 million. After May 15, it goes up to $95 million.

Analysts say the biggest accounting impact of a repurchase would be to PeopleSoft's past results. If Momentum's balance sheets had been combined with PeopleSoft's, it would have taken 22 cents a share away from earnings in 2000, a year in which the company reported earnings of 13 cents a share, according to Salomon Smith Barney analyst Heather Bellini.

The analyst said that action would have cut 18 cents from earnings in 2001, when First Call expects the company to report 57 cents a share, and would have shaved off 3 cents a share in 2002, when First Call predicts it to report 72 cents a share.

"Future results after that should not be affected," Bellini added. She also said rumors that the company could restate its past results are unfounded.

The repurchase may not change much materially, but it could bring some shocking news to individual investors. Most institutional investors should be aware of the deal, as many of them were given Momentum shares after the spinoff. Though they have long been aware of PeopleSoft's practices with Momentum, some may only just be waking up to the fact that the company's revenue is actually very different from what has been reported.

"I wouldn't be surprised if they didn't know all the details," Evergreen's Hamzaogullari said.