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Shares of the data-mining and customized information delivery company plunged more than $122, wiping out over $9 billion in market value in just two hours. Unsurprisingly, the company delayed plans to sell 6.5 million shares in a follow-on public offering.
MicroStrategy said it will reduce its 1999 reported revenue to between $150 million and $155 million, from $205.3 million. Its earnings of $0.15 per diluted share becomes a net loss between $0.43 and $0.51 per diluted share. The company will also reduce its 1998 revenues to between $95.9 million and $100.9 million, from $106.4 million, and net income to between $0.04 and $0.01 per diluted share, from $0.08 per diluted share.
At issue is the way the company records revenue. In the past, MicroStrategy has recorded revenues for software products upfront, and deferred the recognition of related services until the services are rendered. Going forward, the costs of both software and services will be deferred over the life of the contract, a practice that will decrease revenues and net income near term, but won't diminish the company's revenues or cash flow overall. Either way it makes growth look slower.
Michael Saylor, MicroStrategy's president and chief executive, said the move is an effort to make the company's revenue recognition practices bulletproof at a time when companies are getting increased scrutiny.
What happened to change things at MicroStrategy? The company's software contracts have gotten increasingly complex as its business model has changed. In 1998, MicroStrategy was basically an enterprise software company that licensed software to business customers. As the company evolved into more of a software and services company its deals have gotten more complicated. For example, in January MicroStrategy signed an $11 million deal with financial information services company Primark (NYSE: PMK). Under the agreement, MicroStrategy is licensing it's software, hosting the applications, and deploying it on the Primark network.
"When you get to that kind of deal it's no longer software," Saylor said "Reasonable people disagree over how to recognize [those revenues.]"
Revenue recognition issues aren't new in the dotcom age, of course. They're at the heart of accounting matters. A March 1999 report sponsored by the National Commission on Fraudulent Financial Reporting found that more than half of financial reporting frauds in the study involved overstating revenue.
The issue has moved into the spotlight recently as investors rely more on revenues and less on profits for their favorite high-flying technology stocks. The central question in revenue recognition is this -- when is a sale a sale, and when do companies get to recognize the revenues? The answer varies depending on the industry and nature of the revenues. For example, construction companies often recognize contract revenues in stages, as work is completed, but there are many different methods companies can employ.
Fortune magazine ran a must-read article on revenue recognition in its March 20 issue, and Forbes actually ran an article on the quality and timing of MicroStrategy's revenues in its March 6 issue. Hats off to both magazines for running timely, instructive stories, although I'm not convinced the MicroStrategy deals were as lame as the Forbes piece made it sound.
Regarding the issue at hand, Saylor's right when he says reasonable people disagree over when to book sales. It's not black and white. He says the company's previous deals and revenue bookings were solid, clean business deals overseen by accountants and he'd execute them again. Since business folks and auditors have different world views, I'm not surprised to see differences of opinion emerging.
My take is that shareholders aren't rushing to judgment of MicroStrategy, but their own willingness to pay 687x trailing earnings for a company with an untested, evolving business model that made less than $14 million last year. It's a compelling business, in my opinion, but the more investors are willing to pay airy sums based on tools like price-to-sales, or price-to-earnings -- which don't determine value -- the more they'll lose when high-flying companies stumble.
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