by Gordon Graham, Editor, SoftwareCEO
That's what greeted Todd Wille on his first day heading up Sacramento, Calif.-based Unify Corporation (OTCBB: UFYC) in mid-2000.
The company was under suspicions of cooking the books. Eventually 39 class-action suits were filed against the firm, and its former CEO was sentenced to 51 months in jail for fraud.
Wille had a challenging mission: Sort out the books; report to the SEC; reassure employees, shareholders, and customers; and try to save the company.
He'd worked for Unify before, as VP finance and CFO from 1995 to 1998, and as controller before that. Since he left before any shady dealings began, the board called him back to clean up the mess.
What he did, during five months of sleeping three or four hours a night, has been documented in stories like this one in Business Week.
And it worked: Unify recently reported its highest revenue in seven years, with its first operating profit in five quarters. Beyond that, the firm seems positioned for growth; for example, its software can help the thousands of companies planning to move away from Lotus Notes.
SoftwareCEO recently asked Wille some challenging questions: How can software execs avoid accounting scandals in the first place? And if you inherit one from somebody else, how can you clean it up?
Here are the pragmatic suggestions from a CPA and software CEO who describes himself as a "farm boy from Iowa" who has definitely been there, and done that.
Avoid accounting scandal tip #1: Learn more about financials.
Most CEOs know a bit about financials, but it could be time for you to learn more.
"The most important part of avoiding [trouble] is to make sure the CEO has some understanding of financials," says Wille. "I certainly think that's a benefit I had because of my background."
You may have a background in development, sales, or marketing, with little exposure to accounting. But if you don't know how to read a balance sheet or a P/L statement — or what the difference is — it's time to learn.
Fortunately, good sources are everywhere. Pick up a book on finance, take a course online, or even hire an outside accountant to give you some private tutoring for a few hours.
You don't have to know everything, but at least get the big picture. Learn to decipher the ratios that finance people talk about. You'll be far more qualified to manage your company, and keep it on the straight and narrow.
Avoid accounting scandal tip #2: Watch for receivables unpaid after 60 days.
Wille says one area to watch is your receivables (the money customers owe you.)
"If you have receivables that are aging, that could be a sign of a problem. I'd say 30 days not a big flag, 45 days is starting to look yellow, and by 60 it's turning red."
A customer who doesn't pay is bad news, anyway you look at it.
"If a receivable has not been collected when it is due, there's one of two issues," he says. "Either the customer truly has a cashflow issue, or they felt that they didn't get what they bargained for, there was something else supposed to happen, some other thing behind the scenes, some promise not kept."
That could indicate something untoward about that deal. More on that in the next tip.
Avoid accounting scandal tip #3: If a customer doesn't pay, read the tea leaves to find out why.
Once you have a slow-paying customer, Wille advises, have your finance people find out: Are they stuck, or are they sunk?
"It may be a temporary issue, where some large customer of theirs is late. Or did they have a specific debt payment or something that consumed all the operating cash? Or is the business just in trouble?"
Although your CFO or equivalent should make these inquiries, every CEO should be interested in the answers.
"A lot of judgment comes from reading the tea leaves," he says. "OK, they said this, but what did they really mean? I think typically the CEO has more business acumen, they've been around, where a finance guy is typically a little more black and white.”
So put your heads together after your finance guy makes his phone calls. We're not really talking about collecting receivables, we're talking about sniffing out anything rotten in the books.
Avoid accounting scandal tip #4: Check whether a new customer calls for support within the first 30 days.
"If we land a new large customer, I call my support guys and ask, 'How did the install go?' If they say, 'We don't know, we haven't heard...' that's a yellow flag turning red," says Wille.
"In the old days, people would buy software and install it when they got around to it, but these days people buy software moments before they need it, because nobody wants to buy anything in advance any more."
That's why he says it's fishy if someone buys your software, but never calls support with any of the expected questions about setting it up.
"If it's been more than 30 days and no service contact, that to me could mean the transaction in their view was still not done yet, they're still missing a promise, or they agreed to something they didn't really want to."
Taken to its extreme, that customer might not even exist, and the sale could be a complete fiction. Let's hope you never uncover anything like that.
Avoid accounting scandal tip #5: Look for unexplained assets on your balance sheet.
During the questionable accounting at Unify, Wille says, certain deals were "grossed up.
"So if the value was really a $50K deal, they would make it a $200K deal, and figure out a way to give the customer an extra $150K that the customer would give back to the company."
This was finally exposed through the normal audit process, but not before it had gone on for two years, with the amounts getting larger and larger over time.
The problem is, if you give $150,000 to a customer under the table, that $150K doesn't just "vanish" — it has to show up somewhere in your books.
"During the dark days at Unify, those amounts would end up in 'Other Assets,'" says Wille. "From an accounting perspective, you call it 'pre-paid this' or 'something-snazzy that' — what I refer to as 'funny assets.' And they were never able to substantiate what those numbers were for."
So if your "other assets" are growing but they don't make sense, that's another place to look for potential issues.
"The auditors have much stronger standards today; that was not the case before 1999. Auditors are now scrutinizing much smaller numbers and asking much tougher questions," says Wille.
"The flip side is that one of the beautiful things about software is it's a very flexible business. The revenue recognition rules and accounting literature are very complex and frankly, very interpretable.
"It's tough to get every transaction exactly right," he says. "I would say that almost every software company has a potential revenue recognition issue almost every day. I believe the SEC could come into any company, and find something they could disagree with.
"When we have a complex transaction here at Unify we go into painstaking detail, so we can say, 'Here's the literature, here's how we view this transaction, and here's our conclusion.'
"Can the SEC differ with our conclusion? Yes, because it's a judgment. But did we try to analyze it and fit it into the right category? Yes."
So the key is to be able to justify how you handled that revenue.
Avoid accounting scandal tip #7: Create a signoff process for major deals.
On his return, Wille started a new process that he now calls a best practice: the Big Deal Summary (BDS).
"We instituted a process on larger deals — for us, every transaction over $100,000 -- where we actually have a signoff form that requires the signature of the sales rep, the sales manager or VP, the CFO, and the CEO.
"We all have to sign off on the deal. The language on this form states that each of us has shared all pertinent conversations we've had with the customer, and that's been part of the analysis to make sure the revenue is correct."
That's a simple idea that gets everything out on the table earlier, rather than later.
Avoid accounting scandal tip #8: Ban secret side letters.
Side letters are just one of many tricks used to get around proper accounting. How do they work?
"A sales rep or manager sends a letter to the customer that says, 'Hey, you sign this now, we'll get the revenue credit, and we'll do something for you next quarter...'" explains Wille.
"Well, if we don't bring that to the table, the revenue could be improperly recognized.
"We do send letters to customers as far as future things that we have committed to, but they are upfront. They're included in the contract file, the auditor sees them, our audit committee chairman sees then, and certainly the finance guy and myself see them.
"So if a sales rep has made a commitment or contingency to a customer, we analyze that as part of our decision on whether it's revenue now, or we wait until that contingency is removed.
"We haven't banned letters, but we have certainly banned side letters or secret letters," he says firmly. And so should you.
Avoid accounting scandal tip #9: For new hires in finance, look for software company experience.
A key step in avoiding trouble is to build a good finance team.
Wille says Unify had one when he left, topped off by his training and experience. But the team was weakened and eventually lead astray by two top executives at the company.
As far as building a good team, he says it pays to be selective, and look for previous experience directly in software.
"There are entire books written on revenue recognition for software because it's so complex and so unique," says Wille. "So a finance guy who's good at manufacturing, inventory, workflow, and work-in-process is not necessarily the right guy for a software company."
And he's not in love with credentials.
"Whether they are a CPA or a CMA or so forth is relevant, but not critical," he says. He prefers software industry experience over any other credential.
Avoid accounting scandal tip #10: Watch how a potential CFO handles their personal funds; they'll likely handle the company's money the same way.
It's important to understand what Wille calls "the moral compass of your CFO."
"A lot of that comes back to their background. What did they do in high school? What other jobs have they had? What kind of a risk taker are they?
"Say they worked as a stock broker at one point; well, that's a person who is not afraid of getting on the phone and taking some risk. But they may not be your perfect finance candidate; you may want someone who is a little more conservative."
So how do you get at those core values?
"What kind of car do they drive? What kind of house do they live in? What's their wife or husband like?" asks Wille. "Those are important questions, even though you can't really ask some of those in an interview these days."
He likes the classic gambit of going out to dinner with the prospective new hire and their spouse. OK, but what can you tell from a person's house, or car, or how they order in a restaurant?
For one thing, he says you can tell whether they are over-leveraged, or living within their means.
"It's a matter of where they've been, and their earning for the past five years. Does it fit with what they spend, or are they leveraged with a huge mortgage and a huge loan? Is cash flow important to them — so will they be a little more 'flexible' when it comes to achieving their bonuses?
"How they handle their money personally is an indication of how they will handle the money for the company."
It sounds so simple, yet it's so true.
Now for seven more tips that we hope you never, ever need to implement. These are all drawn from Todd Wille's painful experience as he salvaged and turned around Unify.
Clean up an accounting scandal tip #1: Do layoffs if you must.
When Wille arrived at Unify in 2000, the revenue for the past quarter was $2.5 million, but the company had spent $6.5 million. Gulp.
"We were losing $4 million a quarter, and we had about $6 million in cash, so we were in trouble immediately."
He had no choice but to face reality. And that meant doing a substantial layoff.
"The most difficult thing I had to do was resize the business. That was horrible, I didn't sleep for about three weeks, but I was focused on the 75 people who were staying, instead of the 50 who were let go. That was the only way I got through it."
Clean up an accounting scandal tip #2: Reassure your remaining employees, often.
Over the objections of some of his management team, Wille set out to communicate the facts of the situation to the remaining staff.
"I got us all together at least once a week. I told them what was bad, what was good — we still got enough to make payroll — and what I was doing about it.
"I suppose I was a trusted entity coming back, and I was honest. I told them that we were in trouble, and where we were in trouble, and what I thought our options were."
There was remarkably little turnover in the full-time staff during that period.
For example, Wille says during the first year after the layoffs, only one salaried person left the firm, a father with young children who couldn't afford to miss even a single pay check. Wille agreed with his decision to find a more stable company, and wished him well.
Clean up an accounting scandal tip #3: Come clean, but set the agenda for the disclosures.
In other words, sweeten the bad news with any good news you can find.
When Wille arrived at Unify in August 2000, the previous CEO and CFO had already left under a cloud.
"But there wasn't clarity that they had committed fraud until a year later, because white collar [crime] takes a while to figure out.
"The SEC's chief accountant called me pretty regularly from December to April, because I was late in filing my SEC reports. They weren't done, and I wasn't hurrying as fast as maybe he thought I should.
"I was trying to wait for the business to get better, so I could report, 'Here's the bad, here's the bad, and here's the good,' all on the same day. That didn't fit with his agenda, but that's what I thought was best for the business.
"So they didn't get financial reporting to see how bad the company was until the day I released the last quarter and the four before it. And that last quarter that just ended, we'd made $14,000 profit," he says ruefully.
The point is, you have to come clean; but you can do it more or less on your own timetable.
Clean up an accounting scandal tip #4: Reassure customers, but insist that they pay for support.
Unify's customers didn't react well to the scandal.
Most worried the company would go out of business, leaving them high and dry with no support or future upgrades. Wille knew he had some reassuring to do.
"I went out to the customers, and said, 'Here's where we're at. These numbers were over-inflated, but there's a core business here. The products that you use every day are still the same as you used yesterday and will use tomorrow; the value they bring to you is not impacted.'"
He still remembers one major showdown in London at the start of 2002.
"We had about 50 of our big customers who came to see us. Those were dark days. Everyone had signed up for a support contract, where the normal process was to pay for a year in advance.
"But one of these gentlemen stood up and said, 'I don't want to pay my support contract in advance, because I'm worried about you being here.'
"I took five seconds to look at him. And I thought, 'Oh my God, this is what every single person in this room is thinking, and this guy has actually said it, and I have to find an answer.'
"And I looked him right in the eye, and I said, 'Steve, if you take that attitude and you don't pay your support when you're supposed to, you will get that exact result. I will be out of business.
"You've got to do what you've got to do — which is to continue to pay for support — and I've got to do what I've got to do, which is make sure we get through this.'
"There was silence. And then my biggest customer in the UK, who was so huge that everyone else looked up to them, he said, 'That makes a lot of sense, Todd. What can we do to help you?'
"That was a huge turning point. That conversation spread through all of Europe. That was kind of the dark moment, and it turned out really well."
Clean up an accounting scandal tip #5: Lay on extra support to solve every problem fast.
Speaking of support, Wille didn't scrimp on support to get through the dark days.
"I tried not to tell the customers how bad it was, obviously. They interfaced with the support guys when they had problems, so I made sure we had plenty of those guys, and they took all the calls, and they fixed all the problems as fast as possible."
Clean up an accounting scandal tip #6: Consider taking a pause from selling; for sure, make it low-key for a while.
Support was one thing, but sales was another story.
"The sales tactics had got quite aggressive. They had gotten quite abusive, they were pushing customers, doing all these fancy side letters...
"So I told the sales guys to stop bugging the customers. I said don't call them, or just call and ask about their kids, don't even talk about business."
"I knew that once you ask people about their kids, they will likely ask, 'What are you guys doing with the next release?'"
If someone asked them, the sales guys were allowed to answer, so a few orders for upgrades trickled in. But in the main, the company gave its customers a break from sales calls.
Clean up an accounting scandal tip #7: Let customers yell at you if they have to.
Wille's radical ideas for sales weren't over yet.
"I took our service guy, who had gotten customers out of jams for the past 10 years, so they knew him pretty well, and I made him our chief sales guy.
"I said, 'Frank, you know our top 100 customers. Just start calling them. See where they're at. If they want to yell at you, let them yell at you.'
"I said your job is to call customers, let them yell at you, reassure them that there's somebody here when you call, that we're fine, and we've just got to fix some problems."
He even gave this fellow the title of VP of sales. Of course, the sales team was a little confused by these developments, and some people left. Wille didn't mind; to him, that was all part of the house cleaning.
Bonus tip: Don't be tempted by short-term shortcuts; they will always come back to haunt you later.
Wille's experience at Unify teaches us one critical lesson: Anything you try to hide will eventually come to light.
Any revenue you dishonestly pull into the shorter-term is sure to affect you in the longer term.
But — especially in a public company — there is always intense pressure to come up with positive results. How do you square those two forces: to report great numbers, yet remain scrupulously honest?
"Financial performance is expected and demanded, absolutely," says Wille. "It's a very difficult balance, no question."
He says for many CEOs it comes down to having a board with the proper balance of long-term and short-term interests at heart.
"I am very blessed to have that. Of course, we try to be focused and aware of the short-term, but the real important thing I am judged on is the longer-term performance. My next goal is next year.
"We are not focused on investors who are in for a 60-day window. We're focused on investors who want to be with us for three years.
"The key is not to be tempted," says Wille. "If you're in a situation and you interpret things a little more aggressively, inevitably that will come back later on. And then you will have to fix it; so a problem like that never gets smaller, it just always gets bigger."