April 2000 Newsletter
Issue Four, Volume One

WELL, WELL, WELL...

By Mike Gasior

I CAN’T HELP THIS….SORRY

On March 24th I sent 150,000 people around the world the March edition of this Newsletter. On that day the NASDAQ Composite Index traded up to 5,078.86 which was basically it’s all-time record high. This afternoon, Friday April 14, 2000 the NASDAQ Composite Index closed at 3,321.27. Well, well, well….

Now I promise you that I am not going to rub everyone’s nose in anything since this could all turn around on a dime and still make me look like a huge idiot. All I want to do is remind you of a couple of my comments from a few weeks ago and then I’ll drop it. Or at least drop it for this month.

--"Over the next ten years nearly any other asset category will outperform stocks."

--"The stock market still goes down. We just haven’t seen it in a while."

--"There are lots of people managing money who haven’t got a clue what a bloodbath looks like."

--"In as little as 10 years, college professors will be talking about this period of U.S. stock market history as one of the ‘classic’ speculative bubbles."

--"Of the Internet ‘pure plays’ trading right now, probably 90% of them will not exist in five years."

I stand by all of those statements I made last month with both feet. However I do want everyone clear on another point: As much as it seemed as though the stock market was scaring me, I was neither hoping it would go down, nor was I wishing it would go down. It’s going to be bad for the economy. It’s going to be bad for your business. It will be bad for MY business. Basically, it’s going to be bad.

So here is my update for anyone who cares what I’m thinking now.

--We have another quick 1000 points of downward movement coming on the NASDAQ. A lot of those points might be lost Monday morning as you’re reading this.

--It might be a long, long time before you see 5,000 on the NASDAQ again. For example, if you are currently in first grade, it might be sometime not long after your high school graduation. Sorry for that.

--And finally, if you think the worst is over, you’re wrong. There’s still plenty of time to get out and much more blood to be shed here. Sorry, sorry, sorry.

I am not lying to you when I tell you that I am currently listening to both CNBC and CNN right this very second as they cover the "Market Collapse". They are interviewing the "man on the street" about their thoughts about the market now, and their predictions for Monday morning. Over and over I hear them say, "this isn’t the beginning of a bear market" and that Monday will be "a buying opportunity". The only thought I can have is that they are "like pigs led to the slaughter". And since very few of these "men on the street" have been around this whole stock market thing for very long, I will remind them of an age old axiom of Wall Street they may never have heard: "Bulls make money. Bears make money. Pigs don’t make any money." Perhaps these are words to live by at the moment.

And now to the real subject of this month’s newsletter.

ACCOUNTING IN THE NEW WORLD

A few stories I’ve read in the news lately have made me very concerned about some of the accounting practices that I’m seeing played out. Hopefully these practices are also of concern to regulators and to auditors hopefully, as there is deep concern of a rash of shareholder lawsuits against the management of the companies as well as their audit firms.

On March 20th MicroStrategy Inc., a Virginia based software firm saw their stock drop a spectacular $140 a share, from $226.75 to $86.75 in one day. The reason was a directive from the SEC with regard to how a company must now recognize their revenue. Just so I don’t skip right by the jargon without dealing you any cards here, the catch phrase for this new "problem" for some companies is "revenue recognition". And it’s going to have a massive impact on how some of these dot.com enterprises will be looked at in the future. How they’re looked at by investors. How they’re looked at by juries who will decide whether or not to award billions and billions of dollars to jilted shareholders. Here lies our story…..

EVERYTHING IS NEW

For a guy who spent a big chunk of last months newsletter trying to tell you that everything is NOT new and that history always DOES seem to repeat itself, I must admit that these accounting methods I’m seeing today are new to me. If any of the old "Blue Chip" companies were to have tried some of these techniques we would have had their management tarred and feathered. Then we would have had them thrown into jail. And of course being America, we would lastly have to sue them. But is this what we are doing with this current crop of companies? Well, no. Instead we are bidding their share prices to multiples of 1000 or more times earnings and putting the CEO on the cover of Fortune Magazine naming him/her the next High Tech Genius. Perhaps it’s time for us to get a grip here. At just about any other point in financial history, some of these behaviors would have been considered shady, unethical or just downright illegal.

Let me go through some of the practices one by one and try to explain the relevance of each.

REVENUE RECOGNITION

The premise of the SEC guideline, which ruined MicroStrategy’s day, was that you should recognize revenue when you EARN it. Not when you receive it. Because of this "new" way of recognizing revenue MicroStrategy restated it’s 1999 financials, announcing that instead of earning $.15 per share, they would instead lose somewhere between $.43 and $.51. Also, their sales would drop from $205 million to about $150 million.

The reason was that MicroStrategy’s auditors insisted that some revenue on software consulting contracts be spread over the life of the contract. Not recognizing the revenue at the time that the company received the monies. And there is the gist of the regulation.

Let’s say I pay you for something Monday and you’re supposed to deliver it on Tuesday. And for the sake of the example, let’s say the quarter ends Monday. Does that revenue count toward the quarter ending Monday, or the one beginning Tuesday. Well the SEC says the quarter beginning Tuesday since that’s when you’ll actually "earn" that money I paid you. Because if you don’t deliver the "something" to me you will pay me a refund, effectively returning revenue you already had booked. MicroStrategy had software contracts on which lasted for years, but had gotten large amounts of that money up front. Needless to say, booking that revenue currently makes today’s numbers look fabulous but in truth they will be "earning" that money for years to come.

Just recently, Joanne O’Rourke Hindman filed suit against her former employer, iVillage because, she claims, she voiced concerns about the company’s "marginal and even inappropriate" accounting practices. She also alleged that iVillage was recognizing revenue "in some instances even before the letters of intent were signed." This is especially troubling because she was their CFO. A spokesperson from iVillage said that Ms. Hindman’s charges were "groundless" and pointed out that the SEC and the auditors had no trouble with how they were counting revenue. Hmmmm.

GROSS ME OUT

Since so many companies today have never had a cent of earnings in their history, investors have searched for new ways to apply value to them. Amazon.com had a market capitalization not long ago of $21.6 billion and their founder and CEO Jeff Bezos was one of the wealthiest people on earth. All of that without any earnings. So what have investors settled on as a yardstick to measure with? Revenues. And this is where the plot thickens.

Try to follow this one closely.

Suppose I own a travel agency and you buy a $400 airline ticket from me. Of course I would receive a commission from the airline for that sale. For the sake of keeping the example simple, let’s say my commission cut was $40, and the other $360 goes to the airline.

Now here is your quiz.

--What was my gross revenue on the previous transaction?

$400
$40
If you answered B, that’s because the answer makes perfect sense. If you answered A, perhaps you work for Priceline.com.

Consider the following series of numbers:

$152.2 Million – Priceline.com’s 3rd Quarter reported revenue for 1999

($134 Million) – Priceline.com’s 3rd Quarter "product costs"

$18.2 Million – Priceline.com’s "gross profit" for 3rd Quarter 1999

($120 Million) – Priceline.com’s overhead and expenses for 3rd Quarter 1999

($102 Million) – Priceline.com’s net loss for 3rd Quarter 1999

More mind boggling than that list however, is that their stock had been trading at 23 times it’s "gross revenues" and an even more amazing 214 times it’s "gross profit". How many times it’s earnings you ask? WHAT EARNINGS??!! Yet somehow the world is acting surprised that Priceline’s stock is down something like 68% this year. Yikes!

Now if I was truly running a travel agency I would report the $400 I charged you for that ticket as "gross bookings", of which I would get my commission. Priceline has argued that it can do what it does because they actually become the owners of the tickets for a short time and that they take that risk. So far the SEC and their auditors have had nothing to say about this practice, but many money managers are at least troubled by this practice. I am always quick to admit that I’m not the sharpest pencil in the drawer, but the math seems pretty obvious to me. $360 of revenue to the airline. $40 of revenue to Priceline. If you take an even more simple view, if you consider the "total revenue" being claimed by everyone involved in the transaction, it’s actually $760 of "total sales". Somehow, someway, this really needs to stop.

As I sit here some "talking head stooge" on one of the financial shows JUST mentioned some "darling" of an Internet company who delivers groceries to your house or something. What I couldn’t help but find amusing is that this "darling" company is currently losing $220 million a year. Now that IS gross.

BREAD AND BARTER

So you are reading a company’s reported revenues, but you can at least assume that the revenues are in cash, right? Perhaps very wrong.

Many companies are trading their services for the services of another firms, yet booking the bartered goods or services as if they were cash. For example…

Back on October 26th of 1999, StarMedia Network announced that it’s third quarter results for the year had increased a whopping 44% over the previous year. "Wow", you would think. "That sounds fantastic". Sadly, however, 26% of the $5.6 million of revenue they were reporting had never actually received. Instead they had traded advertising on their web pages for TV and radio ads.

Now the whole idea of barter transactions is not a new thing with media companies, but in the "old days" these sorts of transactions seldom came anywhere near 5% of revenue. But of course, those were the "old days". Here is the list of some of the biggest barterers out there right now.

These are all based on 1999 Third Quarter Results.

StarMedia – 26% barter

EDGAR Online – 25% barter

VerticalNet – 21% barter

WebStakes – 20% barter

Sportsline – 18% barter

Netcentives – 14% barter

EarthWeb – 10% barter

IVillage – 7% barter

Now since this seems at the very least….dirty….some companies have sought to avoid getting caught in any sort of wringer by trying "revenue swapping". For instance:

--I place $1,000,000 worth of advertising on your TV network.

--You place $1,000,000 worth of advertising on my Web Pages.

--I send you a check for $1,000,000.

--You send me a check for $1,000,000

--Viola!! We both just made $1,000,000 in revenue. And we even have the cash to prove it.

What a crock is all I can say. I know how hard it is for my audit firm clients to bust their client’s chops too much over things, but come on. How can you sign off on financials that have this sort of crap in them? I mean, don’t you think all those lawyers are kinda pissed off that they didn’t get to file lawsuits for zillions of dollars over the whole Y2K thing? Don’t you think they could make themselves feel better suing your ass off instead in the form of some class action suit? And how long do you think some of these Internet firms are going to be around for you to bill anyway? Twenty more minutes? Watch your own back here my friends. No one is as worried about your future as you are. Never forget that.

CLIPPING COUPONS

Who doesn’t like a bargain? Anyone who knows me knows that I love them! And so do many of these up and coming e-tailers. I beg your attention once again.

--I sell you a book over the Internet for $50

--You use a coupon to get a $10 discount

Once again, I ask you to take a quiz.

What was my revenue on the previous transaction?

$50.00
$40.00
If you answered B, you will never, ever work for an Internet company. If you answered A, you probably already do.

What many companies will do is book the $50 as revenue, and treat the $10 discount you received on the book as "marketing expenses". This just is blowing my mind here. Doesn’t anyone seem to notice that the company NEVER actually got $50 in cash! Has the whole world gone insane? Never mind lawsuits, someone just has to go to jail for some of this stuff. As this NASDAQ continues to bleed out of every orifice of it’s body some people are going to be pretty ticked off. If you still have time to wash your hands of all this, do it quick. Everyone will be looking for someone to blame for all the pain being suffered.

LACK OF FULFILLMENT

There is quite a group of companies (Amazon.com, 1-800-FLOWERS, E-Toys and many, many others) who are being quite cute, and somewhat coy with the subject of "fulfillment costs". These are the expenses incurred in the packaging, storage and shipment of the goods and services they provide. So what are the companies doing that is so "cute"? They are calling these costs "marketing expenses".

So what’s the big deal with that Mike? Well for starters, anything that can be considered as "cost of sales" eats into profit margins. You already know that lots of these companies are operating on razor thin profit margins and they can’t afford to let them get thinner still. But "marketing expenses" might be just part of a huge splurge that the company is spending during their startup which won’t continue. Hmmmm. Pretty slick I’d say.

You at least have to give KPMG some credit for standing up to a client on this issue. Back in October textbook e-tailer Varsitybooks.com fired KPMG for objecting to the lumping of fulfillment costs into the marketing expenses. But is the practice of doing that really risky? Well not if the company doesn’t end up out of business I suppose.

I’LL DROP THE SUBJECT NOW

You are all getting sick of me busting on these poor Internet companies and I’m even sick of listening to myself. But you might be missing the real point here. I don’t own any of these stocks. I don’t care if they all go out of business. It doesn’t matter to me in the least. But what I truly DO care about is the welfare of my audience, which now includes you. I don’t want YOU to lose any money. I don’t want YOU to be hurt professionally by unwittingly allowing some of these practices to happen on your watch. This is the honest truth of it. What is most scary is that I only have time to scrape the tip of the iceberg in this newsletter.

My final thought? Watch yourself. And my advice if you continue to hold on to any of these Internet stocks? Take both your hands, reach around and grab your ass. There….now maybe you won’t lose it.

BERMUDA

We have scheduled a series of seminars to be held at the Sonesta Beach Resort in Bermuda the week of November 27th through December 1st. The courses currently being considered by us are Mortgage & Asset Backed Securities, Derivatives and Private Placements. Please e-mail me directly if you have suggestions or requests about courses or course content. We will make the final decision sometime within the next 10 days and we will post the schedule and costs on the Website at http://www.afs-seminars You can also review the seminar content and schedules there as well.

NEXT MONTH

I will be seeing many of you in the next few weeks as my travels take me to Grand Cayman, Los Angeles and Chicago for seminars. I think the Mortgage & Asset Backed Securities Seminar I will be hosting in Los Angeles and Chicago is one of the most important I offer if your firm trades these securities. Visit the Website at http://www.afs-seminars.com for the dates and to register.

As always I appreciate you comments, both good and bad. Keep those cards and letters coming.

Next month I hope to re-visit the topics of T+1 and decimalization for a quick update, and of course, any timely news that my come up in the meantime.

If you would like to add anyone to the distribution list, or change the e-mail address where you receive this newsletter, you can also accomplish this at the Website at http://www.afs-seminars.com.

Copyright 2000, Michael Gasior. All Rights Reserved.

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