Imagine you're a pretty savvy gambler who just won your office's March Madness pool. Would you start declaring as revenue the money you expect to win from next year's tournament?
Probably not. But that appears to be one of the things that
Gemstar-TV Guide International
has been doing since 1999: continuing to report licensing revenue from a onetime customer which that year ceased to pay for Gemstar's technology, and basing that revenue recognition on the presumption that Gemstar will emerge victorious in its 2-year-old litigation with that former customer.
That optimism, as revealed in the company's 10-K filed Monday, along with a separate disclosure about noncash advertising revenue for the fiscal year ended Dec. 31, prompted analysts at CIBC World Markets, Deutsche Banc Alex. Brown and Salomon Smith Barney to hoist quality-of-revenue warning flags, sending Gemstar's shares tumbling as far as 36% Tuesday.
On Tuesday, Gemstar's shares closed down $5.35, or 37.26%, to $9.01.
At issue in the company's licensing revenue is Gemstar's revelation that since 1999, it has recognized $107.6 million -- $58.9 million in 2001 alone -- in licensing revenue from cable TV equipment company
, related to S-A's manufacturing of set top boxes using Gemstar's interactive program guide technology. The 2001 figure amounts to 18% of the company's technology and licensing revenue.
The problem, however, is that Gemstar hasn't been able to collect any of that money from S-A, possibly because S-A sued Gemstar in federal court in June 1999. S-A, which been licensing Gemstar's technology since 1997, sought a declaration that certain Gemstar patents were invalid or not infringed by S-A. The two companies have been locked in litigation over the matter since then, and Deutsche Banc analyst Karim Zia notes that a decision in the case is at least 12 months away.
Gemstar says it decides whether to recognize revenues from expired licenses, including S-A's, based on such factors as whether the licensee continues to ship products similar to those covered by the expired license, the opinion of outside counsel, the company's belief it will ultimately realize the revenue, and whether the company and licensee are engaged in good faith discussions.
Clouding the issue is a separate legal proceeding between Gemstar and S-A, this one in the U.S. International Trade Commission. That patent case was to be decided last month, but the administrative law judge hearing the case delayed issuing a ruling until as late as June.
In the meantime, that $107.6 million in S-A-related revenue amounts to 27% of Gemstar's $392.7 million in receivables as of Dec. 31. Including S-A's portion, $223.4 million in receivables, or 57%, is owed to Gemstar by a total of five companies.
Investors who saw Gemstar's full-year 2001 financial results press release last month would be forgiven for concluding that the company's 30% year-over-year Technology and Licensing revenue growth came from actual licensees, not former licensees who are current litigants.
"The results of the Technology and Licensing Sector are largely dependent on the activities of our licensees. ... Our revenue is directly correlated to the activities of our licensees," said Gemstar CEO Henry Yuen in last month's release. "During the year, we signed a significant number of new service provider licensees, now almost 140 licensees in the U.S. These new licensees ... position the Company to benefit for many years from the per sub/per month license fees that service providers pay to the Company."
Elsewhere in the 10-K, Gemstar said that out of the $101.4 million in revenue it recognized in 2001 related to advertising and commerce on the company's interactive program guides, $20 million came in the form of barter, not cash. In return for that $20 million worth of advertising and a payment of $750,000 cash, Gemstar received unspecified intellectual property valued at $20.8 million from an unnamed unrelated company. Gemstar added that it also received an option to buy the company, under certain conditions, in 2002 or 2003.
Gemstar added that a "significant" amount of IPG cash advertising revenue came from licensees, vendors or strategic partners.
Analysts' reaction to Gemstar's disclosures was mixed. Salomon Smith Barney analyst Niraj Gupta cut his rating on the company from buy to neutral, the second cut he's made in the company in the past two weeks. Zia, however, reiterated his buy rating and $40 price target, calling the volatile stock "attractive at these levels." Neither analyst's firm has done recent underwriting for Gemstar.