Business software maker MicroStrategy Inc. (MSTR) said Thursday its first-quarter profit declined, as increasing operating expenses overshadowed growth in product license revenue and support. Investors appeared to be surprised by the news, taking the shares down more than 16% Friday.

They shouldn’t have been. I warned three months ago that MicroStrategy looked cheap for a reason:

A look at recent customer wins shows a concentration of retail, financial and healthcare markets. Not exactly the clients one wants during a consumer and financial crunch.

Indeed, it looks as though the toll was already being felt when MicroStrategy reported third-quarter results. Although gross accounts receivable were basically flat during the first nine months of 2007, the allowance for doubtful accounts was increased by nearly 50% to $2.8 million. This suggests that the company may be having trouble collecting from some customers.

Both net income and cash flow from operating activities declined during the first nine months of 2007. Though service and maintenance revenue grew, product licenses declined more than 3%. Since customers must license a product before they can service or maintain it, the falling product licenses suggest that profits may continue to fall, especially if customers indeed prefer the convenience of one-stop shopping offered by IBM (IBM), Oracle (ORCL) and SAP (SAP).

In fact, profits would have been lower still had MicroStrategy expensed all of its software development costs, as it did in early 2006. In the first nine months of 2007 $2.7 million of such costs were capitalized, and the capitalized software balance increased by $1 million. Had the development costs been expensed as incurred, cash from operations would have been $2.7 million (4%) lower and net income would have been $641,000 ($0.05 per share) lower.

The allowance for doubtful accounts continued to rise, despite continued declines in the gross receivables. And the capitalized software costs are coming back to bite, as the expenses are now being recognized and no additional costs were capitalized.

To be fair, though, the latest miss came following a run-up in the stock price. Friday’s severe decline in the shares merely leaves me looking like a bit less of an idiot than I did yesterday. Since I wrote the article, MSTR shares are up 4.9%, compared to a 1.4% rise in the S&P 500.

Disclosure: At time of publication, William Trent holds no financial position in the companies mentioned in this article.

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