Revenue recognition deferrals? Contract execution? These and more caused Portal Software (NASDAQ:PRSF) to warn last night that its Q3 revenue would be off 25%. Investors fled and slashed 43% from the stock price in morning trading. What gives?

The billing software and services company had projected Q3 revenue of $33 million but said last night it would come in 25% lower, or $25 million-$26 million. Portal execs provided a list of reasons in the conference call, but two that stand out are "revenue recognition" and "execution issues." The former as in "accounting" and the latter as in "we messed up."

Management's discussion of revenue recognition confusion is -- confusing. Revenue recognition for software firms is standard. Is management saying that it -- and its accountants -- don't read, understand or follow SOP-97? Check this example from the conference call (transcript courtesy of CCBN/StreetEvents):

Chairman and CEO John Little: Two things have changed, both subtle. Continued to do big deals, understand more how deals work in context of customers, more detail[ed] understanding way transactions conducted, way they need to be analyzed. Interpretation of best way to do these in terms of outside auditors is continuing to change, in effect revenue recognition rules changed subtly over time, that's affecting the specific ways to recognize deals. Those are two primary external things happening. Business growing in complexity. Definitely learning from mistakes.

Excuse me? The big changes in software revenue recognition rules came with explanations issued in 1999 and 2000, some of which led to accounting disasters at companies like Legato Systems (NASDAQ:LGTO) and Ravisent Technologies, now Axeda Systems (NASDAQ:XEDA) and many restatements. Former Fool analyst John Del Vecchio, now of the institutional service Behind the Numbers, explained the situation in What is Your Company Hiding? The entire software industry has been on the alert since then about accounting for software revenue recognition, and no manager of, or auditor for, a software firm can credibly claim otherwise.

Either management is warning us of worse trouble ahead, or they just might not be up to the job of building a "business growing in complexity" and "learning from mistakes." Or both.

Execution's song
It gets worse. For "execution issues," try this exchange:

Question 25: Michael Turret - Prudential
Any cases in which customer said I'm not accepting this. Should we be concerned you performed work the customer wouldn't accept?

Answer: John Little
There are a number of issues here but I don't want to dig too deeply into every single case.

Question 26: Michael Turret - Prudential
I'm trying to get at whether these are mechanical or some fundamental issues.

Answer: John Little
You should have no concern about our ability to deliver or the ability of our products to satisfy. It's strictly execution and delivery within contract terms.

I don't think Little answered the question, and I'm certainly relieved to know that it's only little things like "execution and delivery within contract terms." Glad it's nothing serious. (Can you imagine anything like this today from a credible software company, whether Microsoft (NASDAQ:MSFT) or established small fry?)

I won't be at all surprised if there's more trouble coming with next Thursday's earnings release, to which management deferred most questions, and beyond. Investors should be wary and no one should even consider diving in on the bad news. Any possible return is not worth the risk of losing 100%. Remember speech recognition software company Lernout & Hauspie, where the beginning only led to far worse.

The last word is that Portal Software's Sept. 2003 1-for-5 reverse split and subsequent developments support the view that reverse splits are usually signs of a troubled business. For more, enjoy Reverse Splits -- Ouch!

Have a most Foolish weekend!

Motley Fool Senior Analyst Tom Jacobs hopes he knows better today -- he held Ravisent shares during the debacle, but now owns none of these companies but Microsoft.