Accounting for differences: Analyst's report forces a quiet CSC to lift its veil.

Analysts covering Computer Sciences Corp. long ago adjusted to the tight-lipped manner that befits the manager of information systems for security minded clients that include the Department of Defense.

So when the company went out of its way to issue a press release defending its accounting practices earlier this month, it created an industry outcry.

What prompted Computer Sciences to behave out of character was a report by Sanford C. Bernstein & Co. analyst Rod Bourgeois in which the former management consultant lowered his target price for the stock after expressing "ongoing concerns" about the company's accounting patterns.

Bourgeois questioned how the company had managed to cut certain per-employee expenses by 33 percent over the previous four years, while a competitor. Electronic Data Systems Corp., had only managed a 10 percent decrease.

Investors may wonder, he noted, whether the company had improperly classified them as capital expenses.

While Bourgeios didn't accuse the company, his question had incendiary implications. WorldCom Inc. used just such a technique to fool investors for years before declaring bankruptcy last year. After scandals starting with Enron Corp. and continuing over much of the past year, investors are less inclined to give companies the benefit of the doubt. Wall Street firms and their analysts have been a big part of the scandal, which led to reforms such as the Sarbanes-Oxley Act and large conflict-of-interest settlements by Wall Street brokerages.

Like companies, analysts are feeling their ways too, frightened of letting another WorldCom or Enron escape their gimlet eye.

"We know (Computer Sciences) made concerted efforts to lower its overhead costs," said Bourgeois in the report. But he thinks "the magnitude of (Computer Sciences') savings... is somewhat difficult to understand."

The company's stock fell 12 percent on April 2, the day the report was issued. It was trading last week at $29.06.

Computer Sciences refuses to elaborate about the findings in Bourgeois' report. But in its press release, Chief Financial Officer Leon Level said the overhead reductions are due to "operating performance improvement and business mix factors," not from any changes in accounting treatments. Level said the company spent the past two years consolidating its data centers, as well as implementing cost controls on employee travel and the use of subcontractors on its projects.

Contradictory trends

Many of Bourgeois' fellow analysts accepted the company's explanations. Two, including A.G. Edwards & Sons and Jefferies & Co., raised their ratings on the stock within days of Computer Sciences' response.

"(Bourgeois) raised some interesting points and I would have liked to have seen a better response by the company. But I'm not alarmed' said Sam McGee, a fixed-income analyst at Morgan Keegan.

Bourgeois questioned how Computer Sciences managed to cut selling, general and administrative costs per employee even as it added 49 percent to its headcount during the past four years.

Others responded that there isn't a direct correlation between hiring and overhead. Another factor: The worldwide slowdown in information technology spending, which has forced the company to make cuts.

Even Bourgeois, who wouldn't comment for this story, agrees there isn't always a direct correlation between a company's overhead spending and an increase in payroll. He also admitted in the report that it's difficult to compare the company's costs savings to its rivals because of "cost classification differences."

But he found it "counterintuitive" that the capitalized costs related to the high-cost private sector contracts have risen 80 percent over the past two years, despite the fact that the signings of such deals have declined by 65 percent.

Without the increases in capitalized costs, he estimated that Computer Sciences' earnings for the past two years would have been 40 percent lower. He fretted that investors may "question" whether the company is capitalizing costs that should be expensed.

In its response, Computer Sciences said there has been no change in its contract capitalization policy. It also said there is no connection between the costs it places on the asset side of the balance sheet and its overhead costs.

In refusing to discuss the matter, Computer Sciences cited a quiet period related to a $300 million debt offering and the release of its financial results for the fiscal year that ended on March 31.

This is not a familiar spot for the company. Founded in 1959 by two computer pioneers to develop software for Honeywell Corp., it became a computer systems manager for the Defense Communications Agency after acquiring two divisions from the now-defunct IIT Corp.

Today, Computer Sciences provides the computer services for companies such as Wells Fargo and Nortel Networks and continues to maintain its spot as a prime government contractor. Last year, it reported net income of $344 million, a 47 percent increase over the previous year. Revenues rose 9 percent to $11.4 billion.

The company is known for guarding its privacy. Security guards at its Computer Sciences' El Segundo compound once questioned a press photographer after he photographed a stubbed-out cigar on its premises. The company rarely responds to earnings reports by analysts following the stock, preferring to address their questions during quarterly conference calls.

"We don't conduct our business based on what analysts have to say' intoned Mike Dickerson, the company's main spokesman.

Lack of disclosure

Bourgeois conceded there might be "sound logic" in capitalizing certain contract-related costs. But he complained that the company doesn't disclose enough information about what costs it's actually capitalizing and how those decisions could affect future earnings.

"Our caution stems from a lack of information needed to really understand the underlying drivers of (Computer Sciences') reported earnings," he said in the report.

The lack of disclosure affects others in the computer services industry as well.

"There are large buckets of money and capital expenditures and (selling general and administrative) costs that are moving around in their financial statements. But the information is opaque because you don't have the details of the contracts," said Joseph Vafi, Jefferies' San Francisco-based analyst. He was one of the analysts who raised his rating on Computer Sciences, but only because he thought its shares were "oversold."

In an outsourcing contract, Computer Sciences in effect takes over the clients' computer systems and operations. Unlike government contracts, in which the agency keeps its own equipment, private sector outsourcing deals usually require the provider to acquire a clients' old desktop computers, mainframes, and sometimes even the leases on buildings where the equipment is stored.

While the equipment is usually acquired at present book value, much of this depends on assumptions set by an auditor. This means that Computer Sciences has to determine whether a computer can be used for all or part of the life of the contract, or 'none at all. If the company determines that the equipment has enough shelf life, it will then list it as a "capitalized cost" until it is replaced. Once replaced, the company must treat it as an expense.

While generally accepted accounting principles set rules for what can be capitalized, there are gray areas. If Computer Sciences does regular maintenance on 'a computer, it must be treated as an expense. But if the company decides the repairs will extend its useful life, then the expense can be capitalized, says Brett Trueman, an accounting professor at the Hans School of Business at University of California, Berkeley.

The accounting judgments extend to personnel as well. Because Computer Sciences will also hire a client's former tech support staff and take on their benefits, the company could potentially capitalize the salaries and benefits it's paying if the work being done helps to extending the life of equipment.

Computer Sciences maintains it doesn't do this. In its last filing with the Securities and Exchange Commission, Computer Sciences states that it only capitalizes "fixed assets." consistent with "policies generally applicable to property and equipment."

But no one knows whether others are doing so.

The concerns about disclosure follow earlier questions about the stability of the business of Computer Sciences and its chief rivals, International Business Machines Corp. and Electronic Data Systems, amid a worldwide decline in technology spending.

Much of the focus has been on EDS, which has been rocked by trouble since it announced that its earnings would fall far short of estimates last September. In March, that company's chairman and chief executive, Richard Brown, resigned from the company.

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