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Internet Firm Draws Notice
With Fast Write-Off of Pact
By KARA SWISHER and LESLIE SCISM
Staff Reporters of THE WALL STREET JOURNAL
The good news for Internet investors is that more companies are finally turning, or are close to turning, a profit.
But even as attention shifts to the bottom line, accounting issues are being raised.
Take Excite, whose recent accounting for a big marketing pact with Netscape Communications has prompted even some longtime Internet boosters to raise eyebrows. CIBC Oppenheimer analyst Henry Blodget, for one, applauds "the company's creativity and chutzpah" in figuring out a way to book the pact to its advantage. But his conclusion: "It is an aggressive accounting choice that distorts future operating earnings" by making costs "vanish like a puff of smoke."
Robert Hood, Excite's chief financial officer, defends the accounting treatment and says it was well explained in federal filings. "This is clearly a complicated transaction, and I am reluctant to get into the details, but we think [our reporting] has been quite adequate and complete," he says.
Accounting issues are popping up at many companies nationwide -- from alleged outright fraud at consumer-services concern Cendant to practices that have drawn attention at entertainment company Livent and insurers Vesta Insurance Group and PennCorp Financial Group.
What has long insulated the Internet stocks from such questions is that there haven't been earnings, by and large. But a close examination of the Excite-Netscape deal provides a perspective on the brave new world of Internet accounting.
In the case of Excite and Netscape, both companies are in the same business and even use the same big accounting firm. Yet, each has portrayed the new marketing pact in completely opposite ways in recent financial statements. Both Excite, Redwood City, Calif., and Netscape's Netcenter site are attempting to build central destination spots on the Web. By adding e-mail, commerce, content and other features, they hope to attract large numbers of users in order to make money through advertising and electronic-commerce transactions. Hence, Excite's April 29 pact with Netscape, in which Excite agreed to pay $86.1 million in cash and stock warrants to Netscape in exchange for the right to develop and share revenues generated from co-branded search-and-directory and other services.
Excite says it agreed to pay such a hefty amount to a competitor because of the importance of building a brand name and expanding distribution. By linking itself closely with Netscape, which makes the dominant browser used to navigate the Web, Excite is aiming to grab audience, including occupying a dominant spot on Netscape's highly trafficked search page.
While some analysts aren't so sure about the benefits of the deal for Excite given the cost, what has some of them wondering more is the company's quick write-off of a large chunk of the pact's value -- two-thirds of it, or $56.8 million -- as an unusual one-time charge just two months after signing the deal.
The ignored alternative: amortizing the cost of the deal over its two-year term as a normal marketing expense against the revenues associated with the Netscape deal as they work their way through the income statement. That is the route that Oppenheimer's Mr. Blodget, among others, thinks the company should have taken, although he notes that the write-off has been approved by the Securities and Exchange Commission.
But by taking a one-time charge, which many investors tend to ignore, Excite got a big expense behind it and could break even as early as the fourth quarter of this year. On the other hand, a two-year write-off of the Netscape payment would have postponed break-even until possibly the third quarter of next year, according to Mr. Blodget.
"They took the write-down in the same quarter in which they inked the contract. That's awfully fast," says Jack Ciesielski, who publishes the Analyst's Accounting Observer in Baltimore. While noting that a basic accounting rule is to "recognize an impaired asset when it's apparent it has become impaired," he asks: "If the possibility of profit looks so remote, why did they get into this contract in the first place?" Reading from Excite's federal filings, he notes that the company says it anticipates having a loss of $56.8 million on the contract, while bringing in net revenue of $29.3 million. An Excite spokesman said this is a "prudent" method of accounting.
Excite's Mr. Hood says his company did not take the effects on the stock into account when it decided on the one-time charge. "That line of thinking had nothing to do with our decision," he says. "We looked at the four walls of the contract ... and what resulted from it is what we recorded."
At Netscape, however, the $56.8 million wasn't booked as a one-time gain. Instead, Netscape is working the payment through its income statement over the contract's two-year life. Netscape says such treatment is conservative. "Wall Street does not want to see revenue in a wonky way, but as a recurring business line," adds Netscape's head of investor relations Quincy Smith. "It creates a more stable situation for us ... instead of having this one-time heroin hit of revenue."
Generally, Netscape's approach passes muster with accounting experts.
Howard Schilit, who runs the independent Center for Financial Research and Analysis, Rockville, Md., cautions that Internet companies might find it harder to take one-time charges in the future because the SEC already is cracking down on one-time charges designed to "abracadabra, make expenses disappear."
But Credit Suisse First Boston analyst Lise Buyer notes that the stock market has rewarded some companies with aggressive accounting practices, so "he who has been a stickler about accounting has missed a huge opportunity" in stock run-ups.
Abraham Briloff, a noted and now-retired accounting professor, finds a clear "absurdity" in the instance of Excite paying $70 million in hard cash "in return for an asset now deemed to be worth $29 million." But, he adds: "There are so many absurd things happening in the accounting field of late."
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