How Growth Brought Chaos

How Growth Brought Chaos

By Jean Gruss

Editor/Lee-Collier

When you look carefully at Miva's logo, you can make out an arrow pointing skyward in the letter "a" of the company's name.

But if the Fort Myers-based Internet company's recent stock price is anything to go by, perhaps that arrow should be pointing straight down. After hitting a high of $23.70 on Oct. 22, 2004, Miva's stock sank as low as $4.07 on May 11. It has lately been bouncing off its lows at about $6 per share.

The precipitous decline has tarnished the reputation of one of Fort Myers' few publicly traded companies and rising tech stars. The company, which has won accolades for its creativity and rapid growth in years past, appeared headed for the dot.com graveyard in the spring. Auditors Ernst & Young quit certifying its financial statements, the company's chief financial officer resigned and its lawyers went to trial to fight an expensive legal battle over a critical patent with an archrival subsidiary of Yahoo, the Internet powerhouse.

Much of the company's recent troubles can be traced to challenges stemming from four businesses it acquired last year, including what is now the European subsidiary that accounts for nearly half of its $169 million in annual revenues. Growing so fast in such a short time stretched the company's resources to the limit. Miva President Phillip Thune has moved to London temporarily to oversee that operation until someone can be found to run it. Further, the company warned that revenues in 2005 would come in below analysts' expectations because it jettisoned clients it deemed undesirable or were not as profitable as expected.

Sensing trouble, rival tech companies and investment bankers circled around hoping to acquire Miva at a deep discount. On top of that, angry shareholders sued top company executives, alleging accounting and disclosure violations.

Craig Pisaris-Henderson, Miva's 35-year-old chairman and chief executive, appears unbowed despite the setbacks. The company that grew straight through the dot-com industry meltdown has taken aggressive steps to turn the situation around, including hiring new accountants and a new CFO.

While serious challenges remain, one thing sets it apart from other failed tech ventures: It's a profitable enterprise. In 2004, the company earned $17 million, or 65 cents a share, a 10% after-tax margin. The company has little debt and $50 million in cash, according to its last quarterly report. But with competitors such as Yahoo and Google, the company won't be around for long if it's not profitable. In 2004, Yahoo reported profits of $70.8 million on $1.1 billion in revenues, and Google reported $399 million of profits on $3.2 billion in revenues.

While Miva's largest shareholders are mostly the CEO's friends and family who invested in the business early on, Pisaris-Henderson recruited seasoned executives who are independent of the company to serve as directors. They include Daniel Brewster Jr., former president and CEO of magazine publisher Gruner + Jahr USA; Gerald Hepp, a former partner with Plante & Moran, now the 10th largest accounting firm in the United States; and Charles Rothstein, founder of Beringea, a Detroit-based international private equity and investment banking firm that manages $200 million. They helped steer the company through the tumultuous first half of this year, and in July hired new auditors, BDO Seidman. In June, Larry Weber joined the board. He was the "Weber" in the giant public-relations firm Weber Shandwick Worldwide.

Pisaris-Henderson also hired William Seippel in July to be Miva's new CFO. Seippel is an experienced executive who held the same position at AirGate PCS, a Sprint affiliate with $600 million in annual revenues. He's a veteran of more than 20 corporate acquisitions.

On the legal front, the patent battle with Yahoo subsidiary Overture Services ended in a mistrial, and both sides are discussing a settlement. One possible outcome: Yahoo might acquire Miva or get an equity stake in the company in return for dropping the patent dispute, according to Colin Gillis, an analyst with the Boston-based investment banking firm Adams Harkness.

"I'd be more than happy to settle," says Pisaris-Henderson, declining to elaborate. Clearly, the CEO wants to put this episode behind him. Legal costs leaped to $1 million per quarter, and the company estimated legal expenses were as high as $3.5 million in the second quarter of 2005, a sum that could wipe out any quarterly profit.

Chaotic growth

Looking back, 2004 was a transforming year for the company, then known as Findwhat.com. Until then, the company had grown on its own by making money linking advertisers and consumers via the Internet. Using credit cards and leaning on family for help, Pisaris-Henderson had started the business out of his home with a few friends in 1995, including then 16-year-old chief technology officer Anthony Garcia. Today, Pisaris-Henderson owns 5.4% of the shares of the company, an ownership stake that is currently valued at about $10.6 million. His base annual salary is currently $420,000, up 25% from $335,961 in 2004. His bonus in 2004 was $67,000, and he was granted options to buy 100,000 shares at $20.10 a share that expire in 2014.

In 2004, Pisaris-Henderson wanted to replicate his successful business model overseas and went on a buying spree. With the acquisition of London-based Espotting Media in July 2004 for $183.9 million, including $12 million in cash and the rest in stock and options, the company's revenues doubled overnight. Findwhat.com also acquired three other smaller U.S. companies in 2004: Miva, Comet Systems and B&B Enterprises for a total of $39.5 million. Findwhat.com adopted the name of newly acquired subsidiary Miva in June.

"The company grew chaotically," Pisaris-Henderson acknowledges. "The internal functions didn't scale as fast."

One critical internal function that lagged was the accounting department. Auditors Ernst & Young flagged six material weaknesses in Miva's accounting, including the way the company had accounted for acquisitions in 2004 and insufficient expertise on staff to deal with increasingly complex accounting issues.

Pisaris-Henderson agreed with the auditors' assessments and added to the accounting department, hiring a director of internal audit in November 2004 and enlisting auditing firm Grant Thornton to strengthen and test internal accounting controls.

Still, tensions simmered as Ernst & Young challenged the company's recognition of a $120,000 contract. The amount was relatively small and not material to the overall financial statements, but it became a contentious issue that fractured the company's relationship with its auditors. Pisaris-Henderson was particularly incensed with Ernst & Young's audit fees, which had ballooned from $208,600 in 2003 to nearly $2.5 million in 2004. He argued the fees were excessive, especially considering that rival Google had paid $1.6 million in auditing fees the same year. A spokesman for Ernst & Young declined to comment.

"It's not fun being a small, publicly traded company," says Pisaris-Henderson, revealing a slight hint of regret at having taken the company public in 1999 at the height of the tech boom.

In November, Pisaris-Henderson recruited Hepp to join the company's board and become chairman of the audit committee. Hepp brought to the board more than 32 years of corporate accounting experience. A consultant since 1999, Hepp was an expert in forensic accounting for the government in the Enron case.

In January, Hepp led the company's efforts to find new auditors in view of replacing Ernst & Young. Meanwhile, Pisaris-Henderson and then-CFO Brenda Agius started discussing her eventual resignation. Pisaris-Henderson declined to go into details of her resignation except to say that the decision was mutual because Miva faced "a different threshold of responsibility" as a publicly held company.

The disagreements with Ernst & Young reached a climax in late April. Although it certified the company's first-quarter results, the accounting firm told Miva's board it was resigning. Pisaris-Henderson suspects Ernst & Young caught wind of the board's search for new auditors and resigned before they could be fired.

Although the dual resignation of the CFO and auditors wasn't related to any kind of fraud or accounting misstatements, many investors burned by corporate scandals of recent years headed for the exits.

On May 2, the company announced the accountants' resignation and Miva' stock dropped 26% to $5.71 the next day. The stock recovered slightly on May 4 to $6.16 per share. But on May 5, the company said Agius was resigning as CFO, and the stock dropped 22% to $4.83. (Agius still works for Miva and is currently senior vice president of administration.)

Pisaris-Henderson kicked the search for Agius' replacement into high gear by enlisting the help of recruiting firm Heidrick & Struggles. A month ago, he hired Seippel. Miva had to pay up for the new CFO: at $275,000, Seippel's salary is about 35% more than Agius' base salary when she resigned. He's guaranteed a $50,000 bonus this year and has been granted options to buy $100,000 shares at $5.04 per share. The options vest 25% on each anniversary date of the grant.

Meanwhile, Hepp and the board hired BDO Seidman on July 11; the company plans to announce second-quarter results on Aug. 15.

Tough challenges ahead

Despite the hiring of new auditors and CFO, the company faces ongoing challenges. Pisaris-Henderson says he wants to reach a settlement with Yahoo, though he declined to say what terms he would find acceptable.

On Aug. 15, Pisaris-Henderson intends to clear up the earnings and revenue outlook for the company. Uncertainty over the earnings has been a big reason the stock has remained depressed. That uncertainty stems in part from Miva ditching clients it deemed undesirable. Pisaris-Henderson declined to name the companies in question or the impact on Miva's profits, but he said the former clients didn't follow Miva's distribution guidelines. In company filings with the Securities and Exchange Commission, Miva said it had removed gambling-related advertising from its network, for example. The company also said the severed relationships had accounted for 5% of its revenues and warned that this percentage would eventually be higher, though it wouldn't say exactly how much or what the impact would be on earnings. Pisaris-Henderson says it just makes more sense to focus on more profitable clients. In the end, he says, Miva will be stronger.

Miva must also integrate its new businesses, particularly its new European subsidiary. Pisaris-Henderson flies to London every six weeks via Atlanta because there are no nonstop flights from Fort Myers. He hopes to hire someone to head up the European operations so Thune, Miva's president, can return to the company's headquarters.

Also looming is a significant date: Jan. 1, 2006. That's when Miva will be required to treat employee stock options as an expense rather than as a footnote to its financial statements. It's not clear how that will affect the company's profits, in large part because the future value of the shares is unknown. But in its 2004 annual report, the company showed that accounting for stock options as an expense would have slashed reported earnings in half. And in the first quarter ended March 31, the company would have reported a net loss of $311,000 instead of net income of $3.2 million.

"It's going to be tough," says Pisaris-Henderson. Because Miva is considerably smaller than rivals Yahoo and Google, it hasn't been able to match employee salaries with cash alone, he says. The fact that rivals will have to expense options is small consolation.

And to add to Pisaris-Henderson's challenges, on Aug. 3 he learned that Brewster, the former president and CEO of Gruner + Jahr USA, had resigned from the board. Miva said the resignation was due to Brewster's other personal and professional commitments and had nothing to do with any disagreements with company executives. For Pisaris-Henderson, it was just another day of turning chaos to order.

What Does Miva Do?

Miva is an Internet marketing company with three divisions:

• Miva Media links thousands of advertisers and with consumers online. Advertisers such as Ford and eBay pay Miva for each click or call that results from Miva placing online ads on thousands of Web sites with which it has partnered. Miva Media also creates Web portals for companies such as Lycos and Verizon Superpages.com.

• Miva Direct creates consumer desktop software customized with a partner's brand and buttons. For example, a fantasy league Web site might offer a desktop icon created by Miva that customers can download to their desktop for an easy link back to the league site.

• Miva Small Business creates software that lets small businesses build online stores with software called Miva Merchant. The software processes payments, synchronizes with accounting software and creates e-mail advertising. Add-on modules can help small businesses offer gift certificate and coupon redemption, make tax calculations and create advanced shipping and fulfillment functions.

Statement of Operations

(Dollars in thousands)

Revenues 2003 2004 % Chg.

United States 72,221 112,172 55%

U.K. 0 38,924

Other Int'l 0 18,374

Total 72,221 169,470 135%

Expenses 2003 2004 % Chg.

Search serving 2,802 6,069 116%

Marketing, sales 40,963 98,979 142%

G&A 8,604 25,145 192%

Product development 1,520 5,548 265%

Goodwill impairment 0 1,140

Amortization 0 5,686

Total Operating Expenses 53,889 142,567 165%

Income from operations 18,332 26,903 47%

Other expense 0 (19)

Net interest income 532 495 -7%

Exchange rate gain 0 339

Income before taxes 18,864 27,718 47%

Income tax expense 7,106 10,690 50%

Net income 11,758 17,028 45%

Balance Sheet

Assets 2003 2004 `% Chg.

Cash and equivalents 22,097 29,220 32%

Short-term investments 37,113 25,004 -33%

Accounts receivable 5,051 26,117 417%

Deferred tax assets 180 2,510 1,294%

Note receivable 2,054 0

Income taxes receivable 758 1,626 115%

Prepaid expenses

and other current assets 2,554 1,555 -39%

Total current assets 69,807 86,032 23%

Property & equipment 4,695 16,755 257%

Goodwill 0 201,183

Vendor agreements 0 18,736

Other intangible assets 0 15,567

Deferred tax assets 0 1,964

Other assets 156 967 520%

Total assets 74,658 341,204 357%

Liabilities 2003 2004 `% Chg.

Accounts payable 1,783 17,255 868%

Accrued expenses 5,987 16,166 170%

Deferred revenue 1,866 5,798 211%

Current portion of

long-term debt 0 3,941

Other current liabilities 0 760

Total current liabilities 9,636 43,920 356%

Deferred tax liabilities 600 5,855 876%

Long-term debt 0 2,573

Other long-term liabilities 115 1,177 923%

Total liabilities 10,351 53,525 417%

Total stockholders' equity 64,307 287,679 347%

Total liabilities and

stockholders' equity 74,658 341,204 357%

Stock Chart

Quarter Ended High Low

March 31, 2005 $18.35 $9.73

Dec. 31, 2004 $23.70 $16.50

Sept. 30, 2004 $22.75 $12.55

June 30, 2004 $26.21 $18.26

March 31, 2004 $22.33 $15.27

Dec. 31, 2003 $19.74 $13.50

Sept. 30, 2003 $27.94 $16.81

June 30, 2003 $21.75 $8.79

March 31, 2003 $10.50 $6.75