In this post-Enron world, Gemstar-TV Guide International Inc.'s decision to account for revenue it hoped it would win through a lawsuit on its balance sheet has unnerved investors concerned about the company's credibility.
Gemstar's share price plummeted 37 percent last Tuesday, after the company disclosed it had recognized $107.6 million in revenue from Scientific-Atlanta Inc. during the past 29 months — even though Gemstar is battling S-A in the courts and no longer collects any money from the set-top vendor.
CEO Henry Yuen defended the practice, saying the patent-infringement suits Gemstar has filed against S-A at the International Trade Commission and in a U.S. court in Atlanta would eventually yield that money.
"We feel the likelihood of non-collection to be minimal," Yuen said.
Gemstar decided to reveal its S-A accounting moves now because the Securities and Exchange Commission "has recently pushed for increased disclosure," Yuen added.
Gemstar had been banking that an initial determination in the ITC case — originally scheduled for release last month — would drive sales of its interactive-program guide, TV Guide Interactive.
News that Gemstar had counted S-A revenue on its balance sheet was somewhat striking, considering that during the ITC's hearing in December, Yuen himself had testified that S-A was not cooperating with Gemstar. Yuen told the ITC that S-A CEO Jim McDonald had told his company the box maker would refuse to port TV Guide Interactive to its set-tops until Gemstar called off its team of patent lawyers.
"Unless the lawsuits are unilaterally dismissed by Gemstar, they [S-A] will not cooperate," Yuen testified.
But the administrative law judge overseeing the case delayed the decision until June.
Analysts also expressed some concern after Gemstar disclosed that $20.8 million of its IPG ad revenue was non-cash and came from a barter deal it made last year with Fantasy Sports.
Salomon Smith Barney analyst Niraj Gupta said the disclosure "raises further concerns about the quality and integrity of [Gemstar's] reported financial results."
Gupta cut his Gemstar rating from outperform to neutral. It was the second time in two weeks that the analyst downgraded the company.
Before last week's news, Gemstar stock had fallen steadily since March 19. That's the day the ITC announced it would delay the decision in Gemstar's patent-infringement case against S-A, EchoStar Communications Corp., Pioneer Corp. and SCI Systems Inc. A day earlier, Gemstar co-president Peter Boylan had announced his resignation.
CIBC RATING CUT
CIBC World Markets analyst John Corcoran downgraded the stock from buy to hold last week.
Corcoran called Gemstar "aggressive" in its accounting. "We believe Gemstar's accounting treatment of this [S-A] item raises issues that Wall Street did not know existed regarding the revenue growth for Tech & Licensing, the quality of the revenue, the risk to the revenue already recognized and the growth rate of cash flow," he said.
At least two law firms — Milberg Weiss and Wolf Popper — filed class-action suits against Gemstar on Thursday, claiming the company artificially inflated revenue it claimed it received from S-A.
Gemstar released a statement in which it claimed to be in full compliance with securities laws and said it "intends to vigorously defend the actions."
The progress Gemstar has made in TV Guide Interactive integration efforts was overshadowed by the accounting concerns. Gemstar unveiled a plug-and-play ITV offering with WorldGate Communications Corp. and Concurrent Computer Corp.
The product, which Gemstar will make available to MSOs by this summer, could pose a threat to middleware companies Liberate Technologies Inc. and Microsoft Corp., since MSOs will be able to deploy many ITV applications without relying on middleware.
"The industry has bypassed middleware," said WorldGate CEO Hal Krisbergh.
Gemstar senior vice president Todd Walker maintained that the company isn't looking to get into the middleware business, but acknowledged that MSOs which use Gemstar would be able to roll out ITV applications from companies such as WorldGate, Wink Communications Inc., ACTV Inc., ICTV Inc. and SeaChange International Inc. without buying middleware.
Liberate chief strategy officer Dave Limp downplayed the Gemstar threat, noting that any ITV product Gemstar wants to integrate still needs approval from Motorola's Acadia lab, which can be an arduous process.
Gemstar stock closed at $10.87 last Thursday. A month earlier, the stock closed at $20.97.