The E-Numbers Game

By Adam Zagorin/Washington

Accountants like to call it "earnings management." Regular folks prefer terms like "cooking the books." Whatever the term of art, there's been an increasing tendency by corporations, particularly dotcoms, to bend the rules of accounting to make their numbers look good.

Last week the rules snapped back with a vengeance when MicroStrategy, a supercharged Vienna, Va., software and Internet company, was forced to restate drastically results it reported in 1998 and 1999. MicroStrategy's stock, which had risen like Icarus--from $7.34 to $333 over the past 12 months--suddenly fell from the sky, losing more than 60% of its value in a single day. More than $11 billion in market value was erased, and the company's brash chairman, Michael Saylor, 35, personally lost $6 billion in paper wealth in less time than it takes to say overvalued dotcom. "There's no doubt this is a bump in the road," Saylor said bravely, "but we signed up to change the world and never believed it was going to be easy."

The accounting fiasco broke a long winning streak. His company, founded more than 10 years ago, sells software that allows firms such as American Express and K Mart to mine the masses of sales and other data they collect to better target customers. MicroStrategy went public in 1998, and the stock took off after the creation of Strategy.com a unit that beams custom-tailored information to subscribers of clients like Ameritrade, the Washington Post and the Wall Street Journal. This month, Saylor announced a $100 million charitable scheme to launch an "Internet university." He says these plans haven't been changed by the news.

MicroStrategy's reversal stems from a practice endemic in dotcom-land--overstating revenues. In the Internet twilight zone, where profits rarely exist, evaluating complex revenue streams can turn more on esoteric judgments than on accounting canon. The right outcome can add billions to a company's stock-market value. "It's a dangerous and uncertain game," says Howard Schilit, president of the Center for Financial Research and Analysis, a forensic accounting firm that issued two early warnings on MicroStrategy. "You know your stock could be dead meat if results are a couple of cents short, so you may sit down with your accountant and see if certain assumptions can be changed."

It's not just the hot start-ups that have had accounting issues. According to a recent study by Bear, Stearns, mainstays like Wal-Mart and Continental Airlines are among 32 companies that have restated their financial results since the Securities and Exchange Commission issued a clarification in December of the rules on recognizing revenues. For accounting firms, the choices are difficult. Challenge the client's bookkeeping, which Saylor insists was conservative, and you may end up without a client; fail to do so, and you face angry shareholders and their lawyers after the books are put right. PricewaterhouseCoopers, MicroStrategy's auditor, did not advise the firm that it had failed to comply with strict revenue accounting rules until the restatement.

None of this makes the SEC happy. The agency has launched a drive to clean up what it calls creative accounting--offenses like excessive restructuring charges, inflated one-time "acquisition charges," and most important, manipulation of revenues to produce a predictable stream of profits or mask a bad quarter. "Think about a bottle of fine wine," says SEC chairman Arthur Levitt. "You wouldn't pop the cork on that bottle before it was ready. But some companies are doing this--recognizing revenues before a sale is complete, before the product is delivered, or at a time when the customer still has options to terminate, void or delay the sale."

That's part of what got MicroStrategy into hot water. In one case, the firm booked the full value of a complex $50 million software-and-service sale even though the money would be collected over a multi-year period. Result after the restatement: the company's 1999 sales were revised downward from $205 million to about $150 million. Earnings vaporized.

MicroStrategy's pain extended beyond its stock-market valuation. The firm canceled a planned $1 billion new-stock offering. That will at least temporarily restrict the company's access to capital, not to mention Saylor's. He had planned to sell shares worth hundreds of millions as part of the offering. Although the stock recovered more than a third of its losses as of last Friday's close, he's now down to his last $5 billion.