Guiding Them Out

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Relations between Gemstar-TV Guide International Inc. and part-owner News Corp. hit bottom last week, after the Pasadena, Calif.-based interactive program guide vendor said it submitted a joint proposal to restructure management.

Although Gemstar declined to detail any management changes that might occur, speculation is that it will involve the ouster of Gemstar founder and chairman Henry Yuen and his top lieutenant, chief financial officer Elsie Leung.

According to published reports citing unnamed sources, Yuen and Leung likely will take non-executive roles at the company, with no operating control. Leung has been under fire for months because of several embarrassing accounting scandals at the company, including booking money the company expected to receive from pending lawsuits as revenue.

A report in The Wall Street Journal
last week said Gemstar's board will likely elevate former Fox Cable Networks Group president Jeff Shell — currently Gemstar's co-president and chief operating officer — into the CEO's chair.

Yuen and Leung likely will split a $50 million payment to leave the company, the Journal
said.

If Yuen resigns — and there is still a possibility that no deal will be reached — it would end his often-contentious 13-year reign over the company he founded.

Yuen started the company in 1989 as VCR Plus — maker of a device that made it easier for television viewers to record shows that would evolve into Gemstar after a series of acquisitions — because he couldn't program his VCR to tape a baseball game. Through a series of acquisitions, Yuen gained control of several electronic programming guide patents, which he vigorously enforced.

EARNINGS DELAY

News of the Gemstar restructuring came as the company announced that it would delay the release of its second-quarter financial results. Gemstar said it delayed the release in order to take more time to evaluate how its recent patent-infringement loss before the International Trade Commission affected its financial results.

Gemstar's accounting problems were first revealed in April, when the company disclosed that it had recognized $107.6 million in revenue from Scientific-Atlanta Inc. since the end of 1999, even though it didn't collect a penny from the set-top vendor during that period. Yuen argued at the time that Gemstar, which was waging a patent-infringement suit against S-A, EchoStar Communications Corp. and Pioneer Corp. before the ITC, expected that a positive ruling would yield a hefty settlement from S-A.

"We feel the likelihood of noncollection to be minimal," Yuen said on a conference call in early April.

But in June, an ITC judge ruled against Gemstar, handing S-A and the other defendants a major victory against Yuen's legal team, which had never lost an infringement suit.

Even after the ITC decision was released, Gemstar declined until last week to adjust the revenue that it attributed to S-A on its books.

Now, the $107.6 million in revenue that it recognized form S-A will be removed from its books.

Gemstar "concluded that the collection of its receivable from Scientific-Atlanta is no longer reasonably assured and will record a full reserve," according to a company statement.

BARTER DEALS

Gemstar also said it will reverse the recognition of about $20 million in 2001 revenue from its TV Guide subsidiary, which will likely reduce the cash flow for its Interactive Platform subsidiary by the same amount. Gemstar disclosed in April that the $20 million that had been booked as ad revenue was actually non-cash, and came from barter deals the company cut with Fantasy Sports last year.

While $20 million is a small number compared to Gemstar's total revenue, Banc of America Securities LLC analyst Doug Shapiro said it could point to bigger problems.

"The aggregate dollars involved are not serious," Shapiro said. "The concern I have is that when you add up these various things, it implies that the revenue at the Interactive Platform division was materially overstated last year. That [division] is the driver of the perceived value of the business.

"They went out early in 2001 and said they would do $100 million in revenue in the IP division, and they barely made it to $100 million," Shapiro added. "Then we find out $20 million of that was barter revenue."

Gemstar said it would likely have to restate its revenue for 2001, and for that reason, it would not be able to sign off on its financial statements under a new Securities and Exchange Commission rule. That has been a hot-button issue in the wake of several major accounting scandals that transpired over the past few months.

According to a Gemstar statement, Yuen, Leung and News Corp. management submitted a proposal for restructuring Gemstar's management to the company's board of directors.

"The proposal includes a settlement of the disputes among the parties," Gemstar said. "Dr. Yuen and Ms. Leung and representatives of News Corp. have recently held discussions concerning these conflicts, and the proposed plan to restructure Gemstar management arose out of these discussions."

FRICTION AT WORK

Neither Gemstar nor News Corp. would detail the extent of their dispute, but the friction between Yuen and News Corp. chairman Rupert Murdoch is no secret.

Yuen has long been known as a tough negotiator, and has managed to alienate most of the cable industry by suing anyone he believes is treading on his broad patent portfolio.

While that stance has helped him in the past — forcing cable operators to play ball and pay high prices for the Gemstar guide — it backfired when Gemstar lost the ITC suit. That ruling caused Gemstar stock to plummet.

Gemstar was already down about 71 percent before the June 21 ITC ruling, and its shares have dropped another 57 percent since then.

News Corp., which owns a 42 percent stake in Gemstar, made a move to stop the bleeding earlier this year by installing Shell as co-president and chief operating officer of Gemstar and pressuring Gemstar to disclose the S-A accounting.

Soon after Shell's appointment, News Corp. took a $4.2 billion non-cash charge against its earnings to reflect the decline in value of that investment.

At the time, Murdoch said Shell's appointment was made to help turn Gemstar around, and that he and other News Corp. executives were keeping a close eye on the company.

"I and other senior members of the News Corp. management team are spending a great deal more time with Henry [Yuen] and Jeff to oversee both operations and external financial reporting of their company," Murdoch said on a conference call with analysts in May. "We believe very strongly in the strategic importance of Gemstar."

Murdoch told reporters later that same day that Shell's appointment was in part made to help smooth relations with cable operators.

"This is a company that had sued customers rather than make friends of them," Murdoch said. "We see a turnaround in that."

But in its latest earnings conference call — on Aug. 14 — Murdoch was strangely silent about Gemstar.

"I can't say anything, particularly at this time," Murdoch said on his latest conference call with reporters. "It's up to Gemstar to make any announcements."

Murdoch's silence came after News Corp. had to take another write-down of its Gemstar stake — this time for $1.9 billion.

Shapiro said News Corp. took the latest write-down in accordance with accounting rules that require impairments to goodwill be charged all at once, rather than amortized over a period of time. However, News Corp.'s decision to write down the asset twice in the same year was telegraphing bad news to come, he added.

"The way I believe the ruling works is that you have to revise the value only once a year," Shapiro said. "Anything more is discretionary on the part of the accountants, and you only have to record a charge when the asset is permanently impaired.

"When News took the second charge, it was the judgment of somebody that this investment was permanently impaired. It seems like they were telegraphing this."

CABLE NETS SURGE

Without the one-time non-cash charge, News Corp. would have reported earnings of $114 million (8 cents per share), down from earnings of $145 million (12 cents per share) in the same period last year.

Despite the downturn, News Corp.'s cable networks showed strong performance, reporting operating cash flow of $34 million in the period, versus a $1 million operating loss last year. Revenue rose 29 percent to $564 million. Those gains were despite a $30 million charge from unpaid programming fees related to Adelphia Communications Corp.'s bankruptcy filing.

Although that figure is up from previous estimates, News president and chief operating officer Peter Chernin said on a conference call with analysts that Adelphia has been current with its payments since July 1. Adelphia filed for Chapter 11 bankruptcy protection on June 25.

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